carmax, inc. annual report

CARMAX 2003 C4n1

C A R M A X , I N C . A N N UA L R E P O RTF I SC AL YEAR 2004

C A R M A X M A R K E T S(as of May 1, 2004)

AlabamaBirmingham

CaliforniaLos Angeles (2)Sacramento

FloridaMiami (3)Orlando (2)Tampa (2)

GeorgiaAtlanta (4)

IllinoisChicago (8)

IndianaIndianapolis

KansasKansas City

KentuckyLouisville

NevadaLas Vegas (2)

North CarolinaCharlotte (2)GreensboroRaleigh

South CarolinaColumbiaGreenville

TennesseeKnoxvilleMemphisNashville

TexasDallas/Fort Worth (4)Houston (4)San Antonio

VirginiaRichmond

Washington, D.C./Baltimore (4)

1

22

1

Mid-Sized Markets (17)

Large Markets (8)

Numbers in circles indicate the number of used car superstores in a market.

1

1

1

1

1

1

1

1 1 1

2

1

1 12

2

3

4

4

4

4

8

U S E D C A R S U P E R S T O R E S

COMPELLING MARKET

• Huge• Stable• Non-Commodity• Fragmented Competition • Consumer Need

See page 4.

STRONG RESULTS

• Revenues• Earnings• Return on Invested Capital• Return on Shareholders’ Equity

See page 11.

UNIQUE CONSUMER OFFER

• Low, No-Haggle Prices• Broad Selection • Great Quality • Customer-Friendly Service• carmax.com

See page 6.

SKILLED, DEDICATED PEOPLE

• Training and Development• Store Management Teams• Regional Management Teams• Corporate Management Team

See page 12.

PROPRIETARY PROCESSES

AND SYSTEMS

• Information Systems• Purchasing and Inventory

Management • Reconditioning • Finance Originations

See page 8.

SOLID GROWTH OPPORTUNITY

• Growth Plan• Defensible Competitive Advantage• Outlook

See page 14.

1 2 3

4 5 6

THE CARMAX ADVANTAGE

Cover photo: CarMax’s used car superstore in Henderson, Nevada, one of two superstores opened in the Las Vegas market in fiscal 2004.

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F I N A N C I A L H I G H L I G H T S (Dollars in millions except per share data)

% CHANGE FISCAL YEARS ENDED FEBRUARY 29 OR 28

’03 TO ’04 2004 2003* 2002* 2001 2000

Operating Results

Net sales and operating revenues 16% $4,597.7 $3,969.9 $3,533.8 $2,758.5 $2,201.2

Net earnings 23% $ 116.5 $ 94.8 $ 90.8 $ 45.6 $ 1.1

Separation costs nm $ — $ 7.8 $ 0.4 $ — $ —

Net earnings excluding separation costs 14% $ 116.5 $ 102.6 $ 91.2 $ 45.6 $ 1.1

Per Share Data

Diluted earnings 21% $ 1.10 $ 0.91 $ 0.87 $ 0.44 $ 0.01

Separation costs nm $ — $ 0.07 $ 0.01 $ — $ —

Diluted earnings excluding separation costs 12% $ 1.10 $ 0.98 $ 0.88 $ 0.44 $ 0.01

Other Information

Cash provided by (used in) operating activities 106% $ 148.5 $ 72.0 $ 42.6 $ 18.0 $ (23.6)

Used car superstores at end of year 23% 49 40 35 33 33

Forward-Looking Statements: Statements in this annual report about the company’s future business plans, prospects, and financial performance are forward-looking statementsthat are made in reliance on the safe harbor provisions of the Private Securities Reform Act of 1995. These statements are based on management’s current knowledge andassumptions about future events and involve risks and uncertainties that could cause actual results to differ materially from anticipated results. For additional information on important factors that could affect expectations, see the company’s Securities and Exchange Commission filings, including “Management’s Discussion and Analysis” containedin this annual report.

Separation: On October 1, 2002, CarMax, Inc. was separated from Circuit City Stores, Inc. and became an independent, separately traded public company. Details of the separation are discussed in “Management’s Discussion and Analysis” and the “Notes to Consolidated Financial Statements” contained in this annual report. The consolidatedfinancial statements and related information contained in this annual report are presented as if CarMax existed as a separate entity during all periods presented.

REVENUES(In billions)

COMPARABLESTORE USED UNITSALES (Percentage change)

NET EARNINGS(In millions)

USED CARS SOLD

01 02 03 0401 02 03 04 01 02 03 04

00

(8)

13

24

8

6

00

$2.2

0 $2.7

6 $3.5

3 $3.9

7 $4.6

0

00

$1.1

$45.

6

$90.

8

$94.

8

$116

.5

01 02 03 0400

224,

099

111,

247 13

2,86

8 164,

062 19

0,13

5

Te n ye a r s a f t e r p i o n e e r i n g t h e u s e d c a r s u p e r s t o re c o n c e p t i n 1 9 9 3 , C a r M a x , I n c . i s t h e n a t i o n ’s l e a d i n g

specia lty reta i ler of used cars . At Februar y 29, 2004, CarMax operated 49 used car superstores in 23 markets ,

a s we l l a s 1 2 n ew c a r f r a n c h i s e s , a l l o f w h i c h we re i n t e g r a t e d o r c o - l o c a t e d w i t h i t s u s e d c a r s u p e r s t o re s .

CarMax so ld 224 ,099 used veh ic le s in f i s ca l 2004 , represent ing 91% of the tota l 245 ,740 veh ic le s so ld by the

company during the year.

* Results for fiscal 2003 and fiscal 2002 include costs related to the October 2002 separation of CarMax from Circuit City Stores, Inc.nm = not meaningful


2 C A R M A X 2 0 0 4

T O O U R S H A R E H O L D E R S

W H E R E W E ’ V E B E E N

During the past year, we’ve celebrated some important mile-

stones that reflect just how far we’ve come since we began.

Last July, we sold our 1 millionth car. In late September, we

celebrated our 10th anniversary since opening, and on

October 1, our first anniversary as an independent public

company. As we finished the fiscal year, we hit a few other

impressive milestones:

■ Over 11 million customers greeted with a smile.

■ Over 4.5 million free appraisals and cash offers

to customers.

■ Over 1 million used cars sold.

■ Over $20 billion in cumulative sales.

■ Our 3rd consecutive PricewaterhouseCoopers/

Automotive News award for top 3-year shareholder

return among auto retailers.

All in all, a pretty good first decade for an organic growth

start-up in the retail industry — all thanks to the extraordinary

efforts of the 9,500-plus CarMax associates who’ve joined us

along the way and made it all happen. Twenty-six of the

original 100 associates that were with CarMax the day we

opened the Richmond store on September 29, 1993, are still

a part of our team today. They now play a wide variety of

roles throughout our organization, and their stories are the

story of CarMax’s growth and development.

W H E R E W E A R E

In fiscal 2004 we delivered strong earnings growth, up 14%

excluding the non-deductible separation costs we paid for in

fiscal 2003, and up 23% on a net earnings basis. Our earnings

growth resulted from an 18% increase in used vehicle unit

sales, driven both by our new store openings and 6% compa-

rable store used unit sales growth. With our unique consumer

offer and strong store execution, we continued to take market

share. We hit our gross margin dollars per used unit target for

the year despite a particularly challenging model year

changeover period in the third quarter. Our proprietary buy-

ing and inventory processes and systems continue to help us

“buy right” and “price right.”

This earnings growth was achieved while we absorbed

both the penalty that comes with ramping up our store

growth and the expected decline in CarMax Auto Finance

spreads. As planned, we opened nine used car superstores,

compared with five the previous year. Consequently, SG&A

expense reflected appreciably higher preopening expense, as

well as the significantly higher SG&A ratio of new stores

compared with stores at mature sales levels. We also absorbed

approximately $13.5 million in incremental costs related to

being a stand-alone company compared with fiscal 2003.

Also as expected, CAF income grew a modest 3% for the

year. For more than two years — through the first half of fiscal

2004 — we benefited from much higher than normal spreads

at CAF because market rates for consumer auto loans did not

fall as fast as our cost of funds. During the second half, spreads

returned to more normal ranges. We expect CAF income com-

parisons in fiscal 2005 to be challenging for the first two quar-

ters, and then they should be on a more comparable basis.

W H E R E W E ’ R E G O I N G

We are pleased that CarMax has built a strong foundation

for consistent and profitable growth. We have adjusted our

longer-term used unit comp store growth expectation to a

range of 4% to 8%. We continue to expect to deliver average

annual earnings growth of approximately 20%, once our CAF

income comparisons have cycled around to reflect spreads in

the normal range for each period. Our operating cash flow

Founding Assoc iates , September 1993

Austin Ligon President and Chief Executive Officer


C A R M A X 2 0 0 4 3

provides more than enough resources for our net capital

spending needs, and we have ready availability of attractively

priced debt financing through our inventory facility and real

estate financing relationships. We are now past the vast major-

ity of disruption and costs associated with separating from our

parent company. In fiscal 2005, we expect to incur another

$4 million in incremental stand-alone costs, largely related to

outsourcing our payroll systems, and the following year, we

expect to incur roughly another $3 million to $5 million as

we outsource our computer operations center. We expect this

to be the last major SG&A addition related to our separation.

■ Growth Program. Our growth plan calls for a ramp up

to a 15%–20% annual growth rate of new stores. Our focus for

the first 4 to 5 years of the program is adding satellite fill-in

stores in established markets and standard stores in new mid-

sized markets. These represent the lowest risk, highest early

return opportunities, which help offset the penalties of a growth

program buildup. At year-end, we had opened 15 new stores

plus one replacement store at our LAX location since resuming

growth. Seven of these stores are satellite fill-in stores while the

other eight are standard stores in new mid-sized markets.

This year was the first we’ve grown at a 20% pace, and we

intend to do so again in fiscal 2005 by opening five standard

superstores and five satellite superstores, including a standard

and a satellite store in the Los Angeles market. We do not

expect the L.A. stores to initially perform as strongly as our

regular openings due to a current lack of enough stores to

support TV advertising in L.A. The L.A. stores are intended

to lay the groundwork for an eventual rollout of the entire

market. A satellite opening in Richmond is a continuation of

our efforts to understand how densely we can store an older,

higher-market-share market. In 4 to 5 years, we hope to better

understand what our ultimate market share potential might

be, and therefore how many stores we may eventually be able

to build nationwide.

■ Operational Goals. During fiscal 2005, we have three

major internal goals.

• Quality: First, we want to continue our efforts at contin-

uous quality improvement throughout our operating processes

and particularly our reconditioning process. I believe we have

the best and most consistent inspection, reconditioning, and

certification process in the auto industry — indeed, several

manufacturers have studied our process as the basis for their

own certification programs. But we know there are still errors to

eliminate and efficiencies to be gained. This past year, our sen-

ior operating team studied the quality improvement processes

and cultures of top auto manufacturers like Toyota and Nissan.

Although I believe we’re among the better specialty retailers in

process improvement and significantly ahead of anyone else in

auto retail, our visits to the Toyota and Nissan factories have

helped us understand how much more can be achieved. We are

also taking advantage of data provided by our new electronic

repair order system to improve the quality of our recondition-

ing process while reducing the cost and cycle time involved.

• Associate Development: To open the 10 stores planned

for 2005, we need to generate approximately 140 managers

from our existing base of approximately 700 store-level

managers across the sales, purchasing, service operations,

and business office teams and replace them with internal

promotions and outside hires. It also means identifying,

interviewing, selecting, hiring, and training more than

1,000 additional talented associates in the various operating

departments. To do this smoothly, open the new stores suc-

cessfully, and continue to improve operational execution in

our existing stores is an enormous task. This is, as they say,

Job #1 for CarMax management.

We also believe the broad diversity that we’ve been able

to achieve in both our overall associate teams and our man-

agement teams has given us a significant competitive advan-

tage compared to other auto retailers. We intend to build on

this advantage.

• Company Culture: The entrepreneurial culture of

service and quality that our associates have built as a team

over the last decade has been critical to our success. We’ve

also realized how much fun both we and our customers can

have when you remove all the negatives from the car-buying

process. Yet our own success and growth can become the

enemy if we’re not careful. We want to sustain an enthusiastic,

down-to-earth, non-hierarchical business culture that treats

every associate and every customer with the respect and per-

sonal attention they deserve. A culture where our stores and

store associates come first. They serve our customers, they

create the value in the company, and our job is to support

them and help make their jobs easier in every way we can.

Ultimately, all truly great service and retail companies create a

culture built on similar principles, and they prosper only as

long as they sustain it.

■ Board of Directors Additions. This past year we wel-

comed Fully Clingman and Tom Stemberg to our board of

directors. Fully is the retired president of the H.E. Butt

Grocery Company, named one of the top three supermarket

chains in the nation by the Grocery Manufacturers of

America. Tom is the founder and executive chairman of

Staples, Inc. Together they add enormous depth in big-box

retail experience to our board. We are delighted to have their

expertise as we grow.

Austin Ligon

President and Chief Executive Officer

March 30, 2004


HUGE

■ With annual sales of approximately $366 billion, used

vehicles comprise nearly half of the U.S. auto retail

market, the largest retail segment of the economy.

■ In 2003, there were an estimated 43.6 million used

vehicles sold compared with 16.7 million new vehicles.

■ CarMax’s primary focus — 1- to 6-year-old vehicles — is

a market estimated at $265 billion in annual sales and

20 million units per year.

■ The used vehicle market is substantially bigger than other

large retail categories such as the school and office

products market ($229 billion in estimated annual sales)

and the home improvement market ($212 billion in

estimated annual sales).

STABLE

■ Only twice in the last two decades has the volume of

used unit sales fluctuated by more than 3% from one

year to the next, far less volatile than the annual change

in new car units sold.

■ The market for late-model used cars is almost acyclical.

As the economy improves, buyers who move from used

cars to new cars are replaced by buyers who can now

afford a later model used car.

■ This stability provides the foundation for CarMax’s

market share growth strategy in both existing and

new markets.

COMPELLING MARKET

4 C A R M A X 2 0 0 4

31

-15

-10

-5

0

5

10

15

% Change Used Vehicle Unit Sales % Change New Vehicle Unit Sales2003200119991997199519931991198919871985

U S E D V E H I C L E S A L E S S TA B I L I T Y

(Percentage change)

Source: Manheim Auctions; CarMax estimates; the School, Home andOffice Products Association estimates; and the Home ImprovementResearch Institute estimates

Source: Manheim Auctions

1- to 6- Year-Old

UsedCars

School andOffice

Products

HomeImprove-

ment

U.S.Used CarMarket

$366

$265

$229

$212

R E TA I L M A R K E T S I Z E

(In billions)


C A R M A X 2 0 0 4 5

NON-COMMODITY

■ Unlike new cars, every used car is unique, reflecting

differences in mileage, condition, and age. This uniqueness

provides CarMax the opportunity to add value.

■ We carefully select the vehicles we offer for retail sale.

Our choices are driven by our high quality standards and

our exceptional understanding of consumer buying

preferences at each of our stores.

■ Every retail vehicle undergoes a rigorous reconditioning

process to ensure it meets our high quality standards.

■ We back our quality promise with a 5-day, 250-mile, no-

questions-asked, money-back guarantee and a free 30-day,

industry-leading limited warranty. We also sell extended

service plans that can provide coverage up to 6 years.

FRAGMENTED COMPETITION

■ The U.S. used car marketplace is highly fragmented and

includes 21,700 franchised new car dealers, 54,000

independent dealers, and millions of private individuals.

■ Our primary competitors are the 21,700 franchised

new car dealers who sell the majority of late-model,

1- to 6-year-old vehicles. These dealers focus primarily on

new cars and secondarily on financing and service. Used

car retailing is often a lower priority business for them.

■ Independent dealers predominantly sell older, higher

mileage cars than does CarMax.

■ To date, there have been no successful, large-scale attempts

to replicate the CarMax used car superstore model.

CONSUMER NEED

■ Our consumer research confirms that most consumers

dislike the traditional high-pressure sales tactics employed

by many auto retailers.

■ For more than 20 years, “car salesmen” have ranked last in

the annual Gallup survey on the honesty and ethics of

various professions.

■ The CarMax customer-friendly consumer offer is unique

in auto retailing. We eliminate the traditional adversarial

relationship and let customers shop for cars the same way

they shop at other “big-box” retailers.

S TA B I L I T Y P R O V I D E D B Y C O N S I S T E N T

T U R N O V E R O F V E H I C L E S I N O P E R AT I O N

(Percent annual turnover*)

0

5

10

15

20

25

0302010099989796959493

1 out of 5 vehicles in operation in the U.S. changes hands annually.

* Total used vehicle sales divided by total vehicles in operationSource: Manheim Auctions


6 C A R M A X 2 0 0 4

The CarMax offer is structured around our core equities —

those things we offer customers that, taken together, make us

unique in auto retailing.

LOW, NO-HAGGLE PRICES

■ We offer our best price up front and never haggle on any

element of the sales transaction.

• The price of the vehicle is competitively low and clearlyposted on the car, in the store, and on carmax.com.

• The price of the extended service plan is competitiveand fixed, based primarily on the repair record of similar vehicles and the length of coverage.

• The price of the financing is competitive, no-haggle,and based on the lender’s assessment of credit risk.Customers see the finance offer as it is made directlyfrom the lender and, if approved by more than onelender, may choose among competing offers.

• The price of the “trade-in” is a written cash offer, based solely on the wholesale value of the vehicle, andour offer is good whether the customer buys from us or not. The offer is good for 7 days or 300 miles.

■ Our no-haggle offer streamlines the buying process

and helps ensure that we create only a comfortable,

friendly relationship with customers.

BROAD SELECTION

■ A typical CarMax superstore has between 300 and

400 used vehicles for sale compared with approxi-

mately 90 used vehicles at the average new car dealer.

■ Our primary focus is vehicles that are 1 to 6 years old,

with fewer than 60,000 miles. For the most cost-

conscious consumer, we also offer older, higher mileage

ValuMax cars that meet our same mechanical, electrical,

and safety standards. These older vehicles typically

comprise approximately 15% of our inventory.

■ Each store’s inventory is tailored to the buying

preferences of the consumers in that store’s trade area.

GREAT QUALITY

■ Every used vehicle we sell must meet stringent

mechanical, electrical, and safety standards.

■ Every used vehicle we retail is put through a thorough,

125-point inspection. Needed repairs are made and the

car is thoroughly detailed inside and out to make it look

and feel as close to new as possible.

■ We stand behind our quality standards with our 5-day,

250-mile, money-back guarantee and our industry-

leading, 30-day limited warranty. We also offer extended

service plans on every vehicle we sell that provide up to

6 years of coverage.

2 UNIQUECONSUMER OFFER


C A R M A X 2 0 0 4 7

CUSTOMER-FRIENDLY SERVICE

■ We designed the CarMax offer to give consumers what

they asked for: no haggling on any aspect of the sale, broad

selection, high quality, and a customer-friendly process.

■ To ensure that sales consultant objectives are completely

aligned with those of the customer, we pay our sales

consultants a fixed-dollar-per-unit commission. The sales

consultant earns the same dollar amount regardless of the

price and profit on the vehicle. Consequently, the sales

consultant’s only objective is to help customers find the

right car for their needs at a price they can afford.

■ Our computerized inventory system makes it easy to

search our vehicle inventory.

■ There is no hand-off of customers to a finance manager

or sales manager. The sales consultant helps the customer

through the entire sales process.

CARMAX.COM

■ Carmax.com is a valuable marketing and research tool

that allows customers to see a car’s photo, price, and

specifications, as well as to make side-by-side vehicle

comparisons, all from the comfort of home. We have

sales consultants dedicated to caring for customers who

contact us through the Internet.

■ Using carmax.com, customers can browse our nationwide

inventory of approximately 20,000 used vehicles. This

Web-accessible inventory will continue to expand as we

grow geographically.

■ Any used vehicle in our nationwide inventory can be

transferred at customer request to a local superstore.

Transfers are free within a market; longer-distance

transfers include a charge to cover transportation costs.

■ Currently, more than 10% of our vehicles sold are

transferred at customer request, and approximately 20% of

retail sales are initiated through our Internet sales process.


ConsumerOffer

Purchasing/Inventory

Management

Reconditioning

I N F O R M AT I O N S Y S T E M S

FinanceOriginations

Our business is not unlike an iceberg. Our unique consumer

offer is what draws customers to our stores; it is what can

be seen “above the waterline.” However, our key processes

and systems “below the waterline” are what make our business

successful — sophisticated purchasing and inventory manage-

ment, reconditioning, and finance originations, all supported

by proprietary information systems. Competitors who have

tried to copy our concept have typically failed because they

focused only on our consumer concept. They ignored the

hidden danger of failing to build strong operating processes

early in concept development.

INFORMATION SYSTEMS

■ We recognized at the very beginning of CarMax’s concept

development that management information systems

would be critical to success in the complex used car

retailing business.

■ Our systems capture data on every aspect of our business.

• Every vehicle purchased is electronically trackedthrough its CarMax life from purchase through reconditioning and test drives to ultimate sale. We also capture data on vehicles we wholesale, helping us track market pricing changes.

• In addition, we collect data on activities such as:

> Customer visits.

> Sales consultant/customer engagements.

> Appraisals.

> Extended service plan sales.

> Financings.

■ This information is continually used to enhance

our processes and systems.

■ We believe our processes and systems provide us with a

key competitive advantage. These enabling technologies

have been developed over our more than 10-year history,

and we are dedicated to their continuous improvement to

maintain this competitive edge.

8 C A R M A X 2 0 0 4

3 PROPRIETARYPROCESSES AND SYSTEMS

P R O P R I E TA RY P R O C E S S E S A N D S Y S T E M S


C A R M A X 2 0 0 4 9

PURCHASING AND INVENTORYMANAGEMENT

■ More than half the cars we retail are purchased directly

from consumers, an excellent source of quality, high-

demand vehicles. Customer vehicle purchases that do not

meet our retail standards are sold at our own in-store

auctions, which are an economic and efficient means of

disposal.

■ We have built a team of more than 500 skilled buyers,

150 of whom have each completed more than 10,000

appraisals. Our buyers have online access to data on

current inventory and recent sales, as well as wholesale

industry information.

■ In our 10 years of operation, we have appraised more than

4.5 million customer vehicles, retailed more than 1 million

used cars, and sold nearly 600,000 cars at our auctions.

Information captured and analyzed on each transaction

allows us to continually refine our complex inventory and

pricing models.

■ Our inventory and pricing models help us:

• Buy the mix of makes, models, age, mileage, and pricepoints tailored to the buying preferences at each super-store.

• Recommend pricing adjustments based on complexalgorithms that take into account factors includingsales history, consumer interest, and seasonal patterns.

• Optimize inventory turns to help maintain gross mar-gin dollars per unit and minimize the depreciation riskinherent in used cars.

RECONDITIONING

■ The majority of our service operation resources are

used in vehicle reconditioning, which supports our

used vehicle sales.

■ We employ state-of-the-art production techniques, and

we focus on balancing quality, speed, and cost. Our

production planning process allows us to match

reconditioning capacity and inventory demand across

multiple stores.

■ At the end of fiscal 2003, we rolled out our electronic

repair order system (“ERO”), which optimizes the

sequencing of vehicle reconditioning procedures. ERO

has reduced reconditioning cycle time and is providing

the basis for further quality improvements.

■ Over the past five years, we have reduced our reconditioning

work-in-process cycle time by 50% through our improved

process and production techniques.

■ Automotive technicians are in short supply in the U.S.

We are able to attract and retain skilled technicians by

offering a superior working environment, including air

conditioned bays, a corporate benefit program, and the

opportunity for career advancement. We also have

developed an extensive in-house apprentice program.


1 0 C A R M A X 2 0 0 4

FINANCE ORIGINATIONS

■ CarMax has created a unique finance origination structure

that provides significant customer benefits and competi-

tive advantages.

• The sales consultant collects the customer’s credit infor-mation and electronically submits the loan application toCarMax Auto Finance (“CAF”) and a third-party primelender. If there are no prime offers, the application is auto-matically routed to third-party, non-prime lenders.

• Customers see each offer directly from the lender, and,where multiple offers exist, they may choose the offerthat best suits their needs.

• We provide a 3-day payoff option, which gives cus-tomers up to three business days to replace the loan withcash or an alternative lending source, free of penalty orinterest.

• The sales consultant receives no commission on thefinance process.

■ This structure reduces or eliminates two of the three risks

inherent in used car lending.

• The consumer risk — the customer’s willingness andability to pay — is the basic risk borne by all lenders.

• The collateral risk — the risk of the vehicle — is mini-mized by the consistent, high quality of our cars, thelarge percentage of vehicles covered by extended serviceplans, and the consistency of the relationship betweenwholesale and retail values for CarMax vehicles. CAFand our third-party lenders have found they can rely onCarMax information to determine true vehicle worth.

• The “intermediary” risk — the risk introduced by theperson between the customer and the finance source —is eliminated at CarMax. There is no commission-driven finance manager to distort the facts on the price or quality of the vehicle or the consumer creditinformation. With the price of all components fixed,value-oriented, and non-negotiable at CarMax, bothCAF and third-party lenders benefit from superiorinformation quality in making financing decisions.

■ Having our own finance operation also reduces the sales

risk associated with changes in third-party credit availability.


C A R M A X 2 0 0 4 1 1

4STRONG RESULTS

$(4.

1)

$(5.

2)

$(9.

3)

$(34

.2)

$(23

.5)

$1.1

$45.

6

$90.

8

$94.

8

$116

.5

FY04FY03FY02FY01FY00


$93.

5 $327

.1

$566

.7 $950

.7

$1,6

07.3 $2

,201

.2 $2,7

58.5

$3,5

33.8 $3,9

69.9 $4

,597

.7

FY04FY03FY02FY01FY00FY99FY98FY97FY96FY95

R E V E N U E S

(In millions)

R E T U R N O N I N V E S T E D C A P I TA L

(Unleveraged)

E A R N I N G S

(In millions)

R E T U R N O N S H A R E H O L D E R S ’ E Q U I T Y


FY99FY98FY97

18.9

%

18.2

%20.7

%

12.4

%

0.3%

(6.7

%)

(9.1

%)

(5%

)

(4.1

%)

(0.5

)%

(0.8

)%

(5.3

)%

(0.8

)%

3.5%

8.5%

12.7

%

12.1

%

12.4

%



ROE calculations not meaningful for periods prior to fiscal 1997.


S TO R E M A N AG E M E N T

TRAINING AND DEVELOPMENT

■ In any complex retail business, the primary challenge

and limitation to growth is in the ability to recruit, train,

and develop people.

■ We have formal training programs that span each of our four

functional areas — sales, service, buying, and business office.

The programs include classroom and online training as well

as formal mentoring assignments. Standardized training and

processes also facilitate transfers between stores and regions.

■ We recruit the majority of our superstore managers

from the top big-box retailers across the country,

focusing on individuals with a broad, general

management background and a successful career

progression. Our management training program

includes rotations through each functional area.

■ Our comprehensive workforce planning process looks

forward more than 48 months, considering planned

store openings and anticipated turnover.

1 2 C A R M A X 2 0 0 4

CarMax’s success depends on the skilled and dedicated people who deliver our consumer offer and who develop and execute ourprocesses and systems. The integrity and transparency of the CarMax consumer offer allows us to attract managers andassociates with much more diverse backgrounds than the traditional auto retailer. With access to the best of a broad range ofapplicants, we’ve built a team that can consistently deliver superior customer service, strong leadership, and excellent results.The associates pictured on these pages represent the more than 9,500 employees who contribute to our success.

5 SKILLED,DEDICATED PEOPLE


T E A M S

R E G I O N A L M A N AG E M E N T T E A M S

C O R P O R AT E M A N AG E M E N T T E A M

C A R M A X 2 0 0 4 1 3


1 4 C A R M A X 2 0 0 4

GROWTH PLAN

■ By focusing on used cars, CarMax can grow organically,

unrestrained by new car franchise or manufacturer

restrictions.

■ We resumed our growth plan at the end of fiscal 2002,

following a two-year hiatus during which we concentrated

on improving sales and profits. We opened two superstores

in fiscal 2002, five superstores in fiscal 2003, and nine

superstores in fiscal 2004, including a replacement store

in Los Angeles.

■ During the next three years, we plan to open stores at an

annual rate of approximately 15%-20% of our used car

superstore base, focusing primarily on new mid-sized

markets and adding satellite stores in established markets.

■ We define mid-sized markets as those with television

viewing populations ranging from 1 million to

2.5 million. These markets are the easiest to enter

from a real estate and advertising perspective, and

historically they are where we have experienced the

fastest store ramp-up and profitability.

■ Satellite stores are being added in under-served trade areas

in established multi-store markets and to increase

penetration and market share in established mid-sized

markets. Satellite stores are highly efficient because they

are built on smaller sites and require little or no

incremental advertising.

■ In fiscal 2005, we expect to open 10 superstores,

including four standard stores in mid-sized markets, four

satellite stores in established markets, and two additional

stores in Los Angeles. The L.A. stores will help provide

the foundation for an eventual full-market rollout.

6 SOLID GROWTH OPPORTUNITY

S T O R E E X PA N S I O N

(Number of used car superstores)

FY94

1 24

7

18

29

3335

FY95 FY96 FY97 FY98 FY99 FY00 FY01 FY02

40

FY03

33

49

FY04 FY05 FY06 FY07


C A R M A X 2 0 0 4 1 5

■ We estimate we have an 8%–10% market share of late

model, 1- to 6-year-old used cars within the trade areas

of our most mature stores. This benchmark implies

a $20 billion to $25 billion sales potential in today’s

dollars as our stores reach maturity and we achieve full

national scope.

■ Our market share is significantly higher within a 5-to-

10-mile radius. We are adding satellite stores in older mid-

sized markets to determine optimal storing density, best

storing patterns, and incremental market share

opportunities.

DEFENSIBLE COMPETITIVEADVANTAGE

■ There have been numerous unsuccessful attempts to

replicate the CarMax model. At present, however, we are

fortunate to have no similar-format challengers. This

advantageous competitive landscape is allowing us to

expand on our own timetable, following our own

strategic priorities.

■ CarMax has more than a 10-year development advantage

over any challenger who attempts to copy our business.

Building an organization, developing specialized

processes and systems, refining execution…all take time.

■ CarMax intends to stay ahead of any potential

competition through relentless attention to people,

processes, and execution.

OUTLOOK

■ Over the next several years, we believe we can achieve

comparable store used unit growth in the range of 4%

to 8% per year.

■ In fiscal 2005, we expect comparable store used unit

growth in the range of 3% to 7%, slightly below our

longer-term expectation due to the exceptionally strong

sales base established over the last three years. We expect

total used unit growth in the range of 18% to 22%.

■ We expect fiscal 2005 earnings per share in the range of

$1.21 to $1.26, up 10% to 15% from fiscal 2004. The

benefit of our comparable and new store sales growth is

expected to be partly offset by the return to more

normalized spreads at CAF.


1 6 C A R M A X 2 0 0 4

(Dollars in millions except per share data) FY04 FY03 FY02 FY01 FY00 FY99 FY98 FY97 FY96 FY95

Net sales and operating revenues $4,597.7 $3,969.9 $3,533.8 $2,758.5 $2,201.2 $1,607.3 $950.7 $566.7 $327.1 $ 93.5

Net earnings (loss) $ 116.5 $ 94.8 $ 90.8 $ 45.6 $ 1.1 $ (23.5) $ (34.2) $ (9.3) $ (5.2) $ (4.1)

Net earnings (loss) per share:

Basic $ 1.13 $ 0.92 $ 0.89 $ 0.45 $ 0.01 $ (0.24) $ (0.35) $ (0.10) N/A N/A

Diluted $ 1.10 $ 0.91 $ 0.87 $ 0.44 $ 0.01 $ (0.24) $ (0.35) $ (0.10) N/A N/A

Total assets $1,037.0 $ 917.6 $ 720.2 $ 711.0 $ 675.5 $ 571.2 $448.3 $427.2 $102.6 $114.3

Long-term debt, excludingcurrent installments $ 100.0 $ 100.0 $ — $ 83.1 $ 121.3 $ 139.7 $ 27.4 $ — $ 78.5 $111.6

Used units sold 224,099 190,135 164,062 132,868 111,247 96,915 56,594 31,701 19,618 5,574

New units sold 21,641 22,360 24,164 20,157 17,775 6,152 4,265 2,799 — —

Comparable storeused unit growth (%) 6 8 24 13 (8) (5) 6 7 12 19

Comparable store vehicledollar growth (%) 6 6 28 17 2 (2) 6 23 12 43

Total used unit growth (%) 18 16 23 19 15 71 79 62 252 335

Total sales growth (%) 16 12 28 25 37 69 68 73 250 356

Used car superstoresat year-end 49 40 35 33 33 29 18 7 4 2

Retail stores at year-end 52 44 40 40 40 31 18 7 4 2

Associates at year-end 9,355 8,263 7,196 6,065 5,676 4,789 3,605 1,614 903 146

S E L E C T E D F I N A N C I A L D A T A


The following Management’s Discussion and Analysis(“MD&A”) is intended to help the reader understandCarMax, Inc. MD&A is presented in nine sections: BusinessOverview; Critical Accounting Policies; Results of Operations;Operations Outlook; Recent Accounting Pronouncements;Financial Condition; Contractual Obligations; Market Risk;and Cautionary Information About Forward-LookingStatements. MD&A is provided as a supplement to, andshould be read in conjunction with, our consolidated financialstatements and the accompanying notes contained elsewherein this annual report.

In MD&A, “we,” “our,” “us,” “CarMax,” and “thecompany” refer to CarMax, Inc. and its wholly ownedsubsidiaries, unless the context requires otherwise. Amountsand percents in tables may not total due to rounding.

B U S I N E S S O V E R V I E W

GeneralCarMax was formerly a subsidiary of Circuit City Stores, Inc.(“Circuit City”). On October 1, 2002, the CarMax business wasseparated from Circuit City through a tax-free transaction andbecame an independent, separately traded public company. Wepioneered the used car superstore concept, opening our first storein 1993. Over the next six years, we opened an additional 32used car superstores before suspending new store development tofocus on improving profitability. After a period of conceptrefinement and execution improvement, we resumed used carsuperstore growth in fiscal 2002, adding two stores late in thefiscal year, five stores in fiscal 2003, and nine stores in fiscal 2004.At the end of fiscal 2004, we had 49 used car superstores in 23markets, including 8 large markets and 15 mid-sized markets.

CarMax is the nation’s leading specialty retailer of usedvehicles. The CarMax consumer offer is unique in the autoretailing marketplace. It gives consumers a way to shop for carsthe same way they shop for items at other “big-box” retailers.Our consumer offer is structured around four core equities,including low, no-haggle prices; a broad selection; highquality; and customer-friendly service. We generate revenues,income, and cash flows by retailing used and new vehicles andassociated items including vehicle financing, extendedwarranties, and vehicle repair service. In addition, vehiclespurchased through our appraisal process that do not meet ourretail standards are wholesaled at on-site auctions.

Sales of new vehicles represented a decreasing percentage ofour total revenues over the last three years as we divested newcar franchises and added used car superstores. While furtherfranchise disposals are planned, we expect to keep a smallnumber of core new car franchises in order to maintain long-term strategic relationships with automotive manufacturers.

We provide prime financing for customers through CarMaxAuto Finance (“CAF”) and Bank of America. We also providefinancing for non-prime customers through three third-partylenders. We continue to test additional non-prime lenders, aswell as lenders for sub-prime financing. Having our own

finance operation allows us to limit the risk of reliance onthird-party finance sources, while also allowing us to captureadditional profit and cash flows. The majority of CAF’s profitcontribution is generated from the spread between the interestrate charged the customer and our cost of funds. We collectfixed, pre-negotiated fees from most of the third-party lendersfor each CarMax customer loan they finance.

We sell extended warranties on behalf of unrelated thirdparties who are the primary obligors. Under these third-partywarranty programs, we have no contractual liability to thecustomer. Extended warranty revenue represents commissionsfrom the unrelated third parties.

We are still at an early stage in the national rollout of ourretail concept. The primary drivers for future earnings growthwill be vehicle unit growth from geographic expansion andcomparable store sales increases, and the related expenseleverage. We target a roughly similar fixed dollar amount ofgross profit per used unit, regardless of price, making unitgrowth our primary focus. During the next two-to-three years,we plan to focus our store growth primarily on adding standardsuperstores to new mid-sized markets, which we define as thosewith television viewing audiences between 1 million and 2.5million people, and satellite fill-in superstores in establishedmarkets. In addition, in fiscal 2005 we plan to open two storesin Los Angeles on sites that were purchased prior to suspendinggrowth in 1999. Following these openings, we will have fourstores in Los Angeles, which will provide a foundation forfuture expansion in this market. In fiscal 2006 or 2007, weexpect to once again begin entering additional larger, multi-store markets. Over the three-year period, we plan to open usedcar superstores at a rate of 15% to 20% of our store base eachyear. We also expect used unit comparable store sales increasesin the range of 4% to 8%, reflecting the multi-year ramp insales of newly opened stores as they mature and continuedmarket share gains at stores that have reached mature saleslevels. On a combined basis, we expect that new store openingsand comparable store used unit increases will drive total usedunit growth of approximately 20% annually.

The principal challenges we face in expanding our storebase and meeting our total unit growth targets include:

■ Our ability to procure suitable real estate at reasonablecosts. Real estate acquisition will be an increasing challengeas we enter large, multi-store markets.

■ Our ability to build our management bench strength tosupport the store growth.

We staff each newly opened store with an experiencedmanagement team, including the location general manager,operations manager, purchasing manager, and business officemanager, as well as a number of experienced sales managersand buyers. We must therefore be continually recruiting,training, and developing managers and associates to fill thepipeline necessary to support future store openings. If at anytime we believe that the rate of store growth is causing ourperformance to falter, we will slow the growth rate.

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M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S

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Fiscal 2004 Highl ightsIn fiscal 2004, net sales and operating revenues increased 16%to $4.60 billion from $3.97 billion and net earnings increased23% to $116.5 million, or $1.10 per share, from $94.8million, or $0.91 per share. Sales and earnings were affectedby the following items:

■ We opened nine used car superstores, including five standard-sized stores in new markets and four satellite stores in existingmarkets, including one replacement store in Los Angeles.

■ Total used units increased 18%.

■ Comparable store used units increased 6%. The expectedcannibalization resulting from the addition of satellite storesoccurred somewhat faster than originally projected;however, we do not believe the ultimate amount ofcannibalization will be higher than originally planned. Weare achieving our net incremental sales objectives in themarkets where satellites have been added.

■ Gross profit benefited from a change in our appraisal costrecovery methodology, which is allowing us to more fullyrecover the cost of our buying and wholesaling operations withno adverse effect on the acceptance rate for our appraisal offers.

■ CarMax Auto Finance income increased 3% in fiscal 2004,as the benefit of the growth in our portfolio of CAF loanswas largely offset by the return to more normalized spreadsin the second half of the year. During fiscal 2002, fiscal2003, and the first half of fiscal 2004, CAF benefited fromthe unusually low interest rate environment, with consumerrates falling more slowly than our cost of funds.

■ Selling, general, and administrative expenses as a percent ofsales (the “SG&A ratio”) increased to 10.2% in fiscal 2004from 9.9% in fiscal 2003. Excluding separation costs, thefiscal 2003 SG&A ratio was 9.7%. The increase in theSG&A ratio reflects both the growth penalty associatedwith our resumption of geographic expansion and thehigher costs of being an independent company followingthe separation from Circuit City. New stores generally havehigher SG&A ratios during the approximately four years ittakes to reach mature levels of revenues.

Net cash provided by operations increased to $148.5 millionin fiscal 2004 from $72.0 million in fiscal 2003, driven by theincrease in earnings and a slight reduction in inventory, despiteadding nine used car superstores during fiscal 2004. The decreasein inventory reflects both higher-than-normal inventories at theend of fiscal 2003 resulting from weather-impeded sales inFebruary 2003 and the disposal of four new car franchises duringthe current fiscal year. During fiscal 2004, we completed threesale-leaseback transactions covering a total of nine stores for totalproceeds of $107.0 million and we completed two publicsecuritizations of CAF receivables totaling $1.11 billion.

C R I T I C A L A C C O U N T I N G P O L I C I E SOur results of operations and financial condition, as reflected inthe company’s consolidated financial statements, have beenprepared in accordance with accounting principles generallyaccepted in the United States of America. Preparation offinancial statements requires management to make estimates

and assumptions affecting the reported amounts of assets,liabilities, revenues, expenses, and the disclosures of contingentassets and liabilities. We use our historical experience and otherrelevant factors when developing our estimates and assumptions.We continually evaluate these estimates and assumptions. Note 2to the company’s consolidated financial statements includes adiscussion of significant accounting policies. The accountingpolicies discussed below are the ones we consider critical to anunderstanding of the company’s consolidated financialstatements because their application places the most significantdemands on our judgment. Our financial results might havebeen different if different assumptions had been used or otherconditions had prevailed.

Calculat ion of the Fair Value of Retained Interestsin Securit izat ion Transact ions We use a securitization program to fund substantially all of theautomobile loan receivables originated by CAF. The fair value ofretained interests in securitization transactions includes thepresent value of the expected residual cash flows generated by thesecuritized receivables, the restricted cash on deposit in variousreserve accounts, and an undivided ownership interest in thereceivables securitized through a warehouse facility and certainpublic securitizations. The present value of the expected residualcash flows generated by the securitized receivables is determinedby estimating the future cash flows using management’sassumptions of key factors, such as finance charge income,default rates, prepayment rates, and discount rates appropriatefor the type of asset and risk. These assumptions are derived fromhistorical experience and projected economic trends.Adjustments to one or more of these assumptions may have amaterial impact on the fair value of retained interests. The fairvalue of retained interests may be affected by external factors,such as changes in the behavior patterns of customers, changes inthe strength of the economy, and developments in the interestrate markets. Note 2(C) to the company’s consolidated financialstatements includes a discussion of accounting policies related tosecuritizations. Note 4 to the company’s consolidated financialstatements includes a discussion of securitizations and provides asensitivity analysis showing the hypothetical effect on theretained interests if there are variations from the assumptionsused. In addition, see the “CarMax Auto Finance Income”section of this MD&A for a discussion of the current year impactof changing our assumptions.

Revenue Recognit ionWe recognize revenue when the earnings process is complete,generally either at the time of sale to a customer or upondelivery to a customer. The majority of our revenue is generatedfrom the sale of used vehicles. We recognize vehicle revenuewhen a sales contract has been executed and the vehicle hasbeen delivered, net of a reserve for returns. A reserve for vehiclereturns is recorded based on historical experience and trends.The estimated reserve for these returns could be affected iffuture occurrences differ from historical averages.

We also sell extended warranties on behalf of unrelated thirdparties to customers who purchase a vehicle. Because these thirdparties are the primary obligors under these warranties, we

C A R M A X 2 0 0 4 1 9

recognize commission revenue on extended warranties at thetime of the sale, net of a provision for estimated warrantyreturns. The reserve for returns is based on historicalexperience and trends.

Income TaxesEstimates and judgments are used in the calculation of certaintax liabilities and in the determination of the recoverability ofcertain deferred tax assets. In the ordinary course of business,many transactions occur for which the ultimate tax outcome isuncertain at the time of the transactions. We adjust our incometax provision in the period in which we determine that it isprobable that our actual results will differ from our estimates.Tax law and rate changes are reflected in the income taxprovision in the period in which such changes are enacted.

We evaluate the need to record valuation allowances thatwould reduce deferred tax assets to the amount that will morelikely than not be realized. When assessing the need forvaluation allowances, we consider future reversals of existingtemporary differences and future taxable income. As ofFebruary 29, 2004, we believe that all of our recorded deferredtax assets will more likely than not be realized. However, if achange in circumstances results in a change in our ability torealize our deferred tax assets, our tax provision would increasein the period when the change of circumstances occurs.

In addition, the calculation of our tax liabilities involvesdealing with uncertainties in the application of complex taxregulations. We recognize potential liabilities for anticipated taxaudit issues in the U.S. and other tax jurisdictions based on ourestimate of whether, and the extent to which, additional taxeswill be due. If payments of these amounts ultimately prove to beunnecessary, the reversal of the liabilities would result in taxbenefits being recognized in the period when we determine theliabilities are no longer necessary. If our estimate of tax liabilitiesproves to be less than the ultimate assessment, a further chargeto expense would result in the period of determination.

Defined Benef it Retirement PlanThe plan obligations and related assets of our defined benefitretirement plan are presented in Note 8 to the company’sconsolidated financial statements. Plan assets, which consist

primarily of marketable equity and debt instruments, are valuedusing market quotations. Plan obligations and the annualpension expense are determined by independent actuaries usinga number of assumptions provided by the company. Keyassumptions used to measure the plan obligations include thediscount rate, the rate of salary increases, and the estimatedfuture return on plan assets. In determining the discount rate,we use the current yield on high-quality, fixed-incomeinvestments that have maturities corresponding to theanticipated timing of the benefit payments. Salary increaseassumptions are based upon historical experience andanticipated future board and management actions. Asset returnsare estimated based upon the anticipated average yield on theplan assets. We do not believe that any significant changes inassumptions used to measure the plan obligations are likely tooccur that would have a material impact on the company’sfinancial position or results of operations.

Insurance Liabi l i t iesWe use a combination of insurance and self-insurance for anumber of risks including workers’ compensation, generalliability, and employee-related health care benefits, a portion ofwhich is paid by our associates. We estimate the liabilitiesassociated with these risks by considering historical claimsexperience, demographic factors, and other actuarialassumptions. The estimated liabilities could be affected if futureoccurrences and claims differ from the current assumptions andhistorical trends. We do not believe that any significant changesin assumptions used to estimate insurance liabilities are likely tooccur that would have a material impact on the company’sfinancial position or results of operations.

R E S U L T S O F O P E R AT I O N SCertain prior year amounts have been reclassified to conform tothe current year’s presentation.

Net Sales and Operating RevenuesTotal sales increased 16% in fiscal 2004 to $4.60 billion. Infiscal 2003, total sales increased 12% to $3.97 billion from$3.53 billion in fiscal 2002. Net sales and operating revenuescomponents are shown in Table 1.

TABLE 1

Years Ended February 29 or 28(In millions) 2004 % 2003 % 2002 %

Used vehicle sales $3,470.6 75.5 $2,912.1 73.4 $2,497.2 70.7New vehicle sales 515.4 11.2 519.8 13.1 559.9 15.8

Total retail vehicle sales 3,986.0 86.7 3,431.9 86.4 3,057.1 86.5

Wholesale vehicle sales 440.6 9.6 366.6 9.2 325.6 9.2

Other sales and revenues:Extended warranty revenues 77.1 1.7 68.1 1.7 55.3 1.6Service department sales 69.1 1.5 58.6 1.5 55.9 1.6Third-party finance fees 19.6 0.4 16.2 0.4 15.7 0.4Appraisal purchase processing fees 5.3 0.1 28.5 0.7 24.2 0.7

Total other sales and revenues 171.1 3.7 171.4 4.3 151.1 4.3

Total net sales and operating revenues $4,597.7 100.0 $3,969.9 100.0 $3,533.8 100.0

Total Retail Vehicle Sales. Total retail vehicle sales increased16% in fiscal 2004 to $3.99 billion. In fiscal 2003, total retailvehicle sales increased 12% to $3.43 billion from $3.06 billionin fiscal 2002. For fiscal 2004 and fiscal 2003, the overallincrease in retail vehicle sales reflects the growth in comparablestore used unit sales and the addition of used car superstoresnot yet in the comparable store base. We opened two usedsuperstores late in fiscal 2002, five in fiscal 2003, and nine infiscal 2004, including a replacement store in Los Angeles.Overall, total retail vehicle sales as a percentage of net sales andoperating revenues has remained comparable for all fiscal yearspresented. The increase in used vehicle sales as a percentage ofnet sales and operating revenues offsets the decrease in newvehicle sales. This reflects the fact that we are expanding ourused car superstore base and decreasing the number of new carfranchises that we operate.

Total retail vehicle unit and dollar changes were as follows:

Years Ended February 29 or 282004 2003 2002

Vehicle units:Used vehicles 18 % 16 % 24%New vehicles (3)% (7)% 20%

Total 16 % 13 % 23%

Vehicle dollars:Used vehicles 19 % 17 % 30%New vehicles (1)% (7)% 23%

Total 16 % 12 % 28%

Comparable store used unit sales growth is one of the keydrivers of our profitability. A CarMax store is included incomparable store retail sales in the store’s fourteenth full monthof operation. Comparable store retail unit and dollar saleschanges were as follows:


Vehicle units:Used vehicles 6 % 8 % 24%New vehicles (1)% (3)% 21%

Total 5 % 6 % 23%

Vehicle dollars:Used vehicles 7 % 8 % 30%New vehicles 1 % (3)% 24%

Total 6 % 6 % 28%

Comparable store used unit growth resulted from strongsales execution and the continued benefits of effectivemarketing programs, carmax.com, and word-of-mouthcustomer referrals.

We continue to be pleased with the success of our new marketsand the net sales increases experienced in the markets where wehave added satellite superstores. Expected cannibalization ofcomparable store used unit sales in markets where we have addedsatellite stores is occurring somewhat faster than originallyprojected, which is causing our reported comparable store usedunit growth to be approximately 1% to 2% lower than originallyexpected. Our analysis of these trade areas reinforces our beliefthat the ultimate amount of cannibalization will not be higherthan initially planned. Because we are achieving the netincremental sales objectives for these markets, the faster rate ofcannibalization affects only reported comparable store salesgrowth and does not affect store economics or earnings.

Reduced approval rates from our non-prime customer loanproviders had an adverse impact on comparable store used unitsales growth during the fourth quarter of fiscal 2003. Duringfiscal 2004, the approval rates of our non-prime customer loanproviders gradually returned to historical levels.

Our new car sales performance was generally in line withindustry performance for the brands we sell. We disposed offour new car franchises in fiscal 2004, one in fiscal 2003, andfour in fiscal 2002. The reported new car comparable sales andunits were reduced by the sale of new car franchises at ourKenosha, Wis., auto mall. Because we have multiple new carfranchises within the Kenosha auto mall, we have not adjustedour comparable sales base for the impact of disposing of anyone franchise at this location.

Wholesale Vehicle Sales. Our operating strategy is to buildcustomer satisfaction by offering high-quality vehicles. Fewerthan half of the vehicles acquired from consumers through theappraisal purchase process meet our standards for reconditioningand subsequent retail sale. Those vehicles that do not meet ourstandards are sold at our on-site wholesale auctions. Totalwholesale vehicle units sold at these auctions were 127,168 infiscal 2004; 104,593 in fiscal 2003; and 90,937 in fiscal 2002.The fiscal 2004 increase in wholesale vehicle sales as a percentageof total net sales and operating revenues was due to increasedwholesale appraisal traffic resulting from the expansion of thecompany’s store base and increased consumer response to ourvehicle appraisal offer.

Other Sales and Revenues. Other sales and revenues includeextended warranty revenues, service department sales, third-party finance fees, and, through the second quarter of fiscal2004, appraisal purchase processing fees collected fromcustomers on the purchase of their vehicles.

Appraisal purchase processing fees collected from customerswere designed to cover some of the costs of our appraisal andwholesale operations. During the first quarter of fiscal 2004, wetested an alternative method for recovering these costs. Basedon the test results, during the second quarter the appraisalpurchase processing fees were discontinued across our entirestore base leading to the decrease in these fees as a percentage ofnet sales and operating revenues. Under the revised appraisalcost recovery (“ACR”) method, instead of charging the

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C A R M A X 2 0 0 4 2 1

TABLE 2Years Ended February 29 or 28

2004 2003 2002%(1) $ per unit (2) %(1) $ per unit (2) %(1) $ per unit (2)

Used vehicle gross profit margin 11.3 1,742 10.8 1,648 10.9 1,660New vehicle gross profit margin 3.7 872 4.0 931 4.5 1,054Total retail vehicle gross profit margin 10.3 1,666 9.7 1,572 9.7 1,583

Wholesale vehicle gross profit margin 10.4 359 5.5 192 5.6 202

Other gross profit margin 67.7 472 66.5 534 68.3 548

Total gross profit margin 12.4 2,323 11.8 2,201 11.9 2,228(1) Calculated as a percentage of its respective sales or revenue.(2) Calculated as category gross profit dollars divided by the respective units sold, except the other and total categories, which are divided by

total retail units sold.

customer the appraisal purchase processing fee, we adjust theprice of our purchase offer to allow for full recovery of ourcosts, thereby reducing the acquisition costs of used andwholesale vehicles and increasing used vehicle and wholesalevehicle gross margins. The intent of changing to this method isto recover all costs, including the related costs of land where wehold vehicles before their sale at the wholesale auctions. Thisnew ACR method also makes our offer more transparent to theconsumer by eliminating a fee.

Supplemental Sales Information.

RETAIL UNIT SALES


Used vehicles 224,099 190,135 164,062New vehicles 21,641 22,360 24,164

Total 245,740 212,495 188,226

AVERAGE RETAIL SELLING PRICES


Used vehicles $15,379 $15,243 $15,128New vehicles $23,650 $23,183 $23,128Total vehicles $16,107 $16,078 $16,155

RETAIL VEHICLE SALES MIX


Vehicle units:Used vehicles 91% 89% 87%New vehicles 9 11 13

Total 100% 100% 100%

Vehicle dollars:Used vehicles 87% 85% 82%New vehicles 13 15 18

Total 100% 100% 100%

Impact of Inflation. Inflation has not been a significantcontributor to results. Profitability is based on achievingspecific gross profit dollars per vehicle rather than on averageretail prices. Because the wholesale market for late-model usedcars adjusts to reflect retail price trends, we believe that if thestores meet inventory turn objectives, then changes in averageretail prices will have only a short-term impact on our grossmargin and thus profitability.

Retail Stores. During fiscal 2004, we opened five standard-sized used car superstores and four satellite superstores,including a replacement store in Los Angeles. In Los Angeles, wemerged what had been two stand-alone new car franchises intoone, co-locating it with our new satellite used car superstore.

The following tables provide detail on the CarMax retailstores and new car franchises:

RETAIL STORES

As of February 29 or 282004 2003 2002

Mega superstores(1) 13 13 13Standard superstores(2) 24 19 17Satellite superstores(3) 12 8 5Co-located new car stores 3 2 2Stand-alone new car stores — 2 3

Total 52 44 40(1) 70,000 to 95,000 square feet on 20 to 35 acres.(2) 40,000 to 60,000 square feet on 10 to 25 acres.(3) 10,000 to 20,000 square feet on 4 to 7 acres.

NEW CAR FRANCHISES

As of February 29 or 282004 2003 2002

Integrated/co-located new car franchises 12 15 15

Stand-alone new car franchises — 2 3

Total 12 17 18

Gross Prof it Margin The components of gross profit margin and gross profit perunit are presented in Table 2.

Used Vehicle Gross Profit Margin. In fiscal 2004, 2003,and 2002, we achieved our targets for gross profit dollars perunit. In fiscal 2004, used vehicle gross profit per unit increasedas a result of the change in the ACR methodology. The newACR methodology allows us to recover the expense of ourappraisal, buying, and wholesale operating processes byfactoring those costs into the purchase offers we make. Theacquisition cost of used vehicles purchased directly fromconsumers decreased due to the implementation of the newACR method. Absent the ACR change, we estimate the fiscal2004 gross margin per used unit would have been slightlylower than in fiscal 2003.

New Vehicle Gross Profit Margin. Achieving our newvehicle target gross profit per unit continues to be a challenge.The decline in new vehicle gross margins reflects increasedcompetition, which required more aggressive pricing in order todrive unit sales volume.

Wholesale Vehicle Gross Profit Margin. In fiscal 2004, thewholesale vehicle gross profit margin per unit increasedprimarily due to the implementation of our new ACRmethodology discussed previously. Under the new ACRmethodology, the acquisition cost of wholesale vehiclesdecreased resulting in higher wholesale vehicle gross margins.

Other Gross Profit Margin. Fiscal 2004 other gross profitmargin increased slightly, primarily due to a shift in the mixof the underlying components. Prior to implementing thenew ACR methodology, we had charged customers who soldus their vehicles an appraisal purchase processing fee, whichwas included in other revenues at a 100% gross profit margin.The increases in used vehicle and wholesale vehicle marginsresulting from the new ACR methodology were partiallyoffset by the elimination of the appraisal purchase processingfee and its impact on other gross profit margin. Service sales,which are the only category within other sales and revenuesthat do not carry 100% gross margins, became a larger

percentage of the other category following the elimination ofthe appraisal purchase processing fee. Compared with theprior year, fiscal 2004 service margins improved reflectingincreased service sales and the benefits of our new electronicrepair order (“ERO”) system. In fiscal 2003, service sales andcosts were adversely impacted by the rollout of the EROsystem. Third-party warranty commissions and third-partyfinance fees both benefited from the growth in used car sales.

CarMax Auto Finance IncomeCAF’s lending business is limited to providing prime auto loansfor our used and new car sales. Because the purchase of anautomobile is traditionally reliant on the consumer’s ability toobtain on-the-spot financing, it is important to our businessthat such financing be available to creditworthy customers.While financing can also be obtained from third-party sources,we are concerned that total reliance on third parties can createan unacceptable volatility and business risk. Furthermore, webelieve that our processes and systems, the transparency of ourpricing, and our vehicle quality provide a unique and idealenvironment in which to procure high-quality auto loanreceivables, both for CAF and for third-party lenders. CAFprovides us the opportunity to capture additional profits andcash flows from auto loan receivables while managing ourreliance on third-party finance sources.

CAF income does not include any allocation of indirect costsor income. We present this information on a direct basis toavoid making arbitrary decisions regarding the indirect benefitor costs that could be attributed to CAF. Examples of indirectcosts not included are retail store expenses, retail financingcommissions, and corporate expenses such as human resources,administrative services, marketing, information systems,accounting, legal, treasury, and executive payroll.

The components of CarMax Auto Finance income arepresented in Table 3.

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TABLE 3Years Ended February 29 or 28

(In millions) 2004 % 2003 % 2002 %

Gains on sales of loans(1) $ 65.1 4.7 $ 68.2 5.8 $ 56.4 6.0

Other income(2):Servicing fee income 21.8 1.0 17.3 1.0 14.0 1.0Interest income 16.0 0.8 11.5 0.7 7.7 0.6

Total other income 37.8 1.8 28.8 1.7 21.7 1.6

Direct expenses(2):CAF payroll and fringe benefit expense 8.2 0.4 7.0 0.4 5.7 0.4Other direct CAF expenses 9.7 0.5 7.6 0.4 5.9 0.4

Total direct expenses 17.9 0.9 14.6 0.9 11.6 0.8

CarMax Auto Finance income(3) $ 85.0 1.8 $ 82.4 2.1 $ 66.5 1.9

Loans sold $1,390.2 $1,185.9 $ 938.5Average managed receivables $2,099.4 $1,701.0 $1,393.7Net sales and operating revenues $4,597.7 $3,969.9 $3,533.8Ending managed receivables balance $2,248.6 $1,878.7 $1,503.3

Percent columns indicate:(1) Percent of loans sold.(2) Percent of average managed receivables.(3) Percent of net sales and operating revenues.

C A R M A X 2 0 0 4 2 3

CAF originates automobile loans to CarMax customers atcompetitive market rates of interest. The majority of the profitcontribution from CAF is generated by the spread between theinterest rate charged to the customer and the cost of funds.Substantially all of the loans originated by CAF each month aresold in securitization transactions as described in Note 4 to thecompany’s consolidated financial statements. A gain, recordedat the time of the securitization transaction, results fromrecording a receivable equal to the present value of the expectedresidual cash flows generated by the securitized receivables. Thecash flows are calculated taking into account expectedprepayment and default rates.

CarMax Auto Finance income as a percentage of total netsales and operating revenues decreased in fiscal 2004. Thedecrease was attributable to spreads returning to morenormalized levels during the second half of fiscal 2004. Duringfiscal 2002, fiscal 2003, and the first half of fiscal 2004, webenefited from higher than normal spreads due to consumerloan rates falling more slowly than our cost of funds. The fiscal2003 increase in CAF income as a percentage of net sales andoperating revenues was primarily the result of the $11.8 millionincrease in the gains on sales of loans and the increase in otherincome related to our managed portfolio. The gains on sales ofloans increase resulted from an increase in loans sold driven bya higher sales volume and higher CAF penetration, partiallyoffset by a marginal decline in yield spreads. The increase inother income and total direct expenses was proportionate to theincrease in the managed receivables for all fiscal years presented.

We are at risk for the performance of the securitizedreceivables managed to the extent that we maintain a retainedinterest in the receivables. Supplemental information on ourportfolio of managed receivables is shown in the following tables:

As of February 29 or 28(In millions) 2004 2003 2002

Loans securitized $2,200.4 $1,859.1 $1,489.4Loans held for sale

or investment 48.2 19.6 13.9

Ending managed receivables $2,248.6 $1,878.7 $1,503.3

Accounts 31+ days past due $ 31.4 $ 27.6 $ 22.3Past due accounts as a

percentage of ending managed receivables 1.40% 1.47% 1.48%

Years Ended February 29 or 28(In millions) 2004 2003 2002

Average managed receivables $2,099.4 $1,701.0 $1,393.7

Credit losses on managedreceivables $ 21.1 $ 17.5 $ 12.9

Credit losses as a percentage of average managed receivables 1.01% 1.03% 0.93%

Credit losses as a percentage of average managed receivablesfor fiscal years 2004 and 2003 were comparable. The increasein losses as a percentage of average managed receivables forfiscal 2003 compared with fiscal 2002 was primarily due todepressed wholesale vehicle values which led to lower recoveryrates on repossessed vehicles. The recovery rate was 42% infiscal 2004, 43% in fiscal 2003, and 45% in fiscal 2002. Therecovery rate represents the average percentage of theoutstanding principal balance CarMax receives when a vehicleis repossessed and liquidated.

If the managed receivables do not perform in accordancewith the assumptions used in determining the fair value of theretained interests, earnings could be impacted. Past dueaccounts as a percentage of ending managed receivables werecomparable for all fiscal years presented. In fiscal 2004, weadjusted the cumulative default rate assumptions for certainpools of receivables. We increased the loss rates for two of ourolder pools of receivables to reflect slightly higher losses at theend of the pools’ lives. We also increased the loss rate on currentoriginations from 1.85% to 2.00%, reflecting currenteconomic conditions, including weak recovery rates thatstabilized at historically low levels. There was no change in thecredit quality of the receivables, which was at the high end ofour historical range. The changes resulted in no material impacton earnings or the fair value of retained interests. Detailsconcerning the assumptions used to value the retained interestsand the sensitivity to adverse changes in the performance of themanaged receivables are included in Note 4 to the company’sconsolidated financial statements.

Sel l ing, General and Administrat ive Expenses The SG&A ratio was 10.2% of net sales and operating revenuesin fiscal 2004, 9.9% in fiscal 2003, and 9.5% in fiscal 2002.The SG&A ratio for fiscal 2003 and 2002 included one-timecosts of $7.8 million and $0.4 million, respectively, associatedwith the separation of CarMax from Circuit City. Excludingthese costs, the SG&A ratio would have been 9.7% in fiscal2003 and 9.5% in fiscal 2002.

The fiscal 2004 and fiscal 2003 SG&A ratios reflect theexpected higher level of operating expenses associated withbeing a stand-alone company following the October 1, 2002,separation from Circuit City. We estimated stand-alone costswere approximately $13.5 million higher in fiscal 2004 than infiscal 2003, and approximately $9.0 million higher in fiscal2003 than in fiscal 2002. A majority of these costs related toemployee benefits and insurance.

As anticipated, the fiscal 2004 SG&A ratio was adverselyaffected by the resumption of our store growth plan and theincrease in the number of store openings. New stores typicallyexperience higher SG&A ratios than stores with mature saleslevels, reflecting the sales ramp that occurs over time. Highertotal pre-opening expenses and costs related to building ourmanagement team bench strength to support future storegrowth also contributed to the higher current year SG&A ratio.

Selected Quarterly Financial Data (Unaudited)

(In thousands except First Quarter Second Quarter Third Quarter Fourth Quarter Fiscal Yearper share data) 2004 2003 2004 2003 2004 2003 2004 2003 2004 2003

Net sales and operating revenues $1,172,835 $1,005,803 $1,236,457 $1,080,682 $1,071,534 $936,819 $1,116,865 $946,640 $4,597,691 $3,969,944

Gross profit $ 147,771 $ 122,142 $ 163,105 $ 128,812 $ 126,242 $106,940 $ 133,770 $110,345 $ 570,888 $ 468,239

CarMax Auto Finance income $ 25,748 $ 19,838 $ 22,677 $ 22,110 $ 17,649 $ 19,220 $ 18,889 $ 21,231 $ 84,963 $ 82,399

Selling, general, andadministrative expenses $ 115,553 $ 93,037 $ 120,714 $ 97,997 $ 114,282 $101,810 $ 117,825 $ 99,573 $ 468,374 $ 392,417

Separation costs $ — $ 1,871 $ — $ 1,265 $ — $ 4,479 $ — $ 153 $ — $ 7,768

Selling, general, and administrative expenses excluding separation costs $ 115,553 $ 91,166 $ 120,714 $ 96,732 $ 114,282 $ 97,331 $ 117,825 $ 99,420 $ 468,374 $ 384,649

(Gain)/loss on franchisedispositions $ — $ — $ 460 $ — $ (1,207) $ — $ (1,580) $ — $ (2,327) $ —

Net earnings $ 35,260 $ 29,238 $ 39,610 $ 31,714 $ 19,053 $ 14,717 $ 22,526 $ 19,133 $ 116,450 $ 94,802

Net earnings excludingseparation costs $ 35,260 $ 31,109 $ 39,610 $ 32,979 $ 19,053 $ 19,196 $ 22,526 $ 19,286 $ 116,450 $ 102,570

Net earnings per share:Basic $ 0.34 $ 0.28 $ 0.38 $ 0.31 $ 0.18 $ 0.14 $ 0.22 $ 0.19 $ 1.13 $ 0.92Diluted $ 0.34 $ 0.28 $ 0.37 $ 0.30 $ 0.18 $ 0.14 $ 0.21 $ 0.18 $ 1.10 $ 0.91

Net earnings per shareexcluding separation costs:Basic $ 0.34 $ 0.30 $ 0.38 $ 0.32 $ 0.18 $ 0.19 $ 0.22 $ 0.19 $ 1.13 $ 1.00Diluted $ 0.34 $ 0.30 $ 0.37 $ 0.32 $ 0.18 $ 0.18 $ 0.21 $ 0.18 $ 1.10 $ 0.98

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Income Taxes The effective income tax rate was 38.5% in fiscal year 2004,39.5% in fiscal 2003, and 38.0% in fiscal 2002. The fiscal2003 effective tax rate increased as a result of non-tax-deductible costs associated with the October 1, 2002,separation from Circuit City.

O P E R AT I O N S O U T L O O K

Changes in Store BaseDuring the fiscal year ending February 28, 2005, we plan toexpand our used car superstore base by approximately 20%,opening 10 used car superstores. Planned entries into new mid-sized markets include Indianapolis, Ind.; Columbia, S.C.;Austin, Tex.; and Albuquerque, N.M. Satellite superstoreadditions are planned for Winston Salem, N.C.; Fayetteville,N.C.; Miami, Fla.; and Richmond, Va. We also plan to add astandard superstore and a satellite superstore in the Los Angelesmarket on sites that were purchased prior to suspending growthin 1999. With four stores in the Los Angeles market, we willstill lack the critical mass to support television advertising inthis market. As a result, we do not expect these Los Angelesstores to perform as strongly as our other newly opened storesin their early years.

We still plan to sell or return our remaining four Mitsubishinew car franchises. In addition, we plan to sell our Fordfranchise in Kenosha, Wis. The sale or return of integrated newcar franchises will create more space for used car salesexpansion, which is more profitable for us.

Fiscal 2005 Expectat ionsThe fiscal 2005 expectations discussed below are based onhistorical and current trends in our business and should be readin conjunction with the “Cautionary Information AboutForward-Looking Statements” section of this MD&A.

Fiscal 2005 Total Used Unit Growth. Our revenue andearnings growth expectations are based on expanding our storebase by 15% to 20% annually, as well as on our comparablestore used unit growth. For fiscal 2005, we expect total usedunit growth in the range of 18% to 22%. Total revenues willalso be affected by changes in average retail prices, ourdispositions of new car franchises, and the residual effect of thenew ACR methodology.

C A R M A X 2 0 0 4 2 5

Fiscal 2005 Comparable Store Used Unit Growth. Weexpect fiscal 2005 comparable store used unit growth in therange of 3% to 7%. Fiscal 2005 comparable store growth isstill challenged, we believe, by the exceptionally strong salesbase we established over the past three years, especiallyfollowing the high levels of customer traffic stimulated by thewidespread introduction of 0% financing after the events ofSeptember 11, 2001.

Fiscal 2005 Earnings Per Share. We expect fiscal 2005pretax earnings growth of 12% to 17%. We anticipate that oureffective tax rate will increase from 38.5% to 39.0% as weexpand our store base into states with higher tax rates.Consequently our earnings per share growth will be slightlylower at 10% to 15%, in the range of $1.21 to $1.26.

We expect our gross margin to be favorably impacted by thegrowing mix of used car sales, as we add used car superstoresand divest new car franchises. In addition, we believe arefinement of our ACR methodology will provide anincremental benefit to gross margin.

In fiscal 2005, we expect CAF’s gain as a percent of loanssold to be slightly below the midpoint of our 3.5% to 4.5%normalized range. Therefore, we expect CAF income will berelatively flat with fiscal 2004, despite the anticipated increasein loan volume. Our fiscal 2005 pretax earnings growth wouldbe expected in the range of 19% to 24% if our CAF spreadremained at the 4.7% that it was in fiscal 2004.

In fiscal 2005, we will still be experiencing the growthpenalty of opening new stores, which have higher SG&A rates,while none of our newer stores will have reached mature levelsof revenue. We believe our corporate overhead expenditures asa percent of sales will remain flat compared with fiscal 2004,even though we expect to absorb approximately $4 million inadditional expenses related to being a stand-alone company.Among these expenses are costs related to outsourcing ourpayroll systems, which previously had been supplied by CircuitCity. We also expect another $3 million to $5 million ofincremental stand-alone costs in fiscal 2006 when we outsourceour data center, which is now housed at Circuit City. Thisshould be the last major incremental stand-alone cost increasewe will incur.

Longer-Term Expectat ionsThe longer-term expectations discussed below are based onhistorical and current trends in our business and should be readin conjunction with the “Cautionary Information AboutForward-Looking Statements” section of this MD&A.

We expect used unit comparable store sales increases in therange of 4% to 8% over the next several years, reflecting themulti-year ramp in sales of newly opened stores as they mature.Once CAF income reflects comparative spreads in ournormalized range, we expect the combination of unit growthand expense leverage to deliver average annual earnings pershare growth of approximately 20%.

R E C E N T A C C O U N T I N GP R O N O U N C E M E N T SFor a discussion of recent accounting pronouncementsapplicable to the company, see Note 14 to the company’sconsolidated financial statements.

F I N A N C I A L C O N D I T I O N

Operating Activ it iesWe generated net cash from operating activities of $148.5million in fiscal 2004, $72.0 million in fiscal 2003, and $42.6million in fiscal 2002. The fiscal 2004 improvement primarilyresulted from the increase in net earnings and a slight decreasein inventory, despite adding nine used car superstores duringthe year. The decrease in inventory in fiscal 2004 reflects thecombined effects of a higher-than-normal inventory balance atthe end of fiscal 2003 resulting from weather-impeded sales inFebruary 2003 and the disposal of four new car franchisesduring the current fiscal year. The fiscal 2003 improvementprimarily resulted from an increase in net earnings and anincrease in accounts payable and accrued expenses associatedwith the separation from Circuit City. Prior to fiscal 2003,certain liabilities such as the workers’ compensation liabilitywere recorded through the debt from our former parent andtherefore reflected as financing activities.

Invest ing Activ it iesNet cash used in investing activities was $73.8 million in fiscal2004 and $80.4 million in fiscal 2003. Net cash provided byinvesting activities was $57.5 million in fiscal 2002. Capitalexpenditures were $181.3 million in fiscal 2004, $122.0million in fiscal 2003, and $41.4 million in fiscal 2002. Theincrease in capital expenditures reflects the increase in our storebase associated with the resumption of our growth plan.Additionally, some of the fiscal 2004 increase is associated withthe initial expenditures associated with our future corporateoffice site in Richmond, Va.

Capital expenditures are funded through sale-leasebacktransactions, short- and long-term debt, and internallygenerated funds. Net proceeds from sales of property andequipment totaled $107.5 million in fiscal 2004, $41.6 millionin fiscal 2003, and $99.0 million in fiscal 2002. The majorityof the sale proceeds relate to sale-leaseback transactions. Infiscal 2004, the company entered into sale-leasebacktransactions involving nine properties valued at approximately$107.0 million. In fiscal 2003, we entered into a sale leasebacktransaction involving three superstore properties valued atapproximately $37.6 million and in fiscal 2002 we entered intoa sale leaseback transaction involving nine superstore propertiesvalued at approximately $102.4 million. These transactionswere structured as operating leases with initial terms of either15 or 20 years with various renewal options. At February 29,2004, we owned a total of four CarMax superstores.

In fiscal 2005, we anticipate gross capital expenditures ofapproximately $250 million. Planned expenditures primarilyrelate to new store construction, including furniture, fixtures,and equipment; land purchases associated with future yearstore openings; new corporate offices; and leaseholdimprovements to existing properties. We expect to open tenused car superstores during fiscal 2005, five of which will besatellite superstores.

Financing Activ it iesNet cash used in financing activities was $47.6 million infiscal 2004. In fiscal year 2003, net cash provided byfinancing activities was $39.8 million, compared with netcash used of $105.7 million in fiscal 2002. In fiscal 2004, weused cash generated from operations to reduce totaloutstanding debt by $51.6 million. In fiscal 2003, weincreased total outstanding debt by $67.6 million and paid aone-time dividend of $28.4 million to Circuit City inconjunction with the separation transaction.

The aggregate principal amount of automobile loanreceivables funded through securitizations, which arediscussed in Notes 3 and 4 to the company’s consolidatedfinancial statements, totaled $2.20 billion at February 29,2004, $1.86 billion at February 28, 2003, and $1.49 billionat February 28, 2002. During fiscal 2004, we completed twopublic automobile loan securitizations totaling $1.11 billion.At February 29, 2004, the warehouse facility limit was$825.0 million and unused warehouse capacity totaled$272.5 million. The warehouse facility matures in June 2004.Notes 2(C) and 4 to the company’s consolidated financialstatements include a discussion of the warehouse facility. Weanticipate that we will be able to renew, expand, or enter intonew securitization arrangements to meet the future needs ofthe automobile loan finance operation.

We maintain a $300 million credit facility secured by vehicleinventory. As of February 29, 2004, the amount outstandingunder this credit facility was $104.4 million, with theremainder fully available to the company. See Note 9 to thecompany’s consolidated financial statements for discussion ofexpiration, renewals, and covenants associated with this facility.

We expect that proceeds from securitization transactions;sale-leaseback transactions; current and, if needed, additionalcredit facilities; and cash generated by operations will besufficient to fund capital expenditures and working capital forthe foreseeable future.

Off-Balance Sheet ArrangementsCAF’s lending business is limited to providing prime autoloans for our used and new car sales. We use a securitizationprogram to fund substantially all of the automobile loanreceivables originated by CAF. We sell the automobile loanreceivables to a wholly owned, bankruptcy-remote, specialpurpose entity that transfers an undivided interest in thereceivables to a group of third-party investors. This programis referred to as the warehouse facility.

We periodically use public securitizations to refinance thereceivables previously securitized through the warehousefacility. In a public securitization, a pool of automobile loanreceivables is sold to a bankruptcy-remote, special purposeentity that in turn transfers the receivables to a specialpurpose securitization trust.

Additional information regarding the nature, businesspurposes, and importance of our off-balance sheetarrangement to our liquidity and capital resources can befound in the “CarMax Auto Finance Income,” “FinancialCondition,” and “Market Risk” sections of this MD&A, aswell as in Notes 3, 4, and 5 to the company’s consolidatedfinancial statements.

M A R K E T R I S K

Automobi le Instal lment Loan ReceivablesAt February 29, 2004, and February 28, 2003, all loans inthe portfolio of automobile loan receivables were fixed-rateinstallment loans. Financing for these automobile loanreceivables is achieved through asset securitization programsthat, in turn, issue both fixed- and floating-rate securities.Interest rate exposure relating to floating-rate securitizationsis managed through the use of interest rate swaps.Receivables held for investment or sale are financed withworking capital. Generally, changes in interest ratesassociated with underlying swaps will not have a materialimpact on earnings. However, changes in interest ratesassociated with underlying swaps may have a material impacton cash and cash flows.

Credit risk is the exposure to nonperformance of anotherparty to an agreement. Credit risk is mitigated by dealing withhighly rated bank counterparties. The market and credit risksassociated with financial derivatives are similar to those relatingto other types of financial instruments. Refer to Note 5 to thecompany’s consolidated financial statements for a description of these items.

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C O N T R A C T U A L O B L I G AT I O N SLess than 1 to 3 3 to 5 More than 5

(In millions) Total 1 Year Years Years Years

Contractual obligations:Long-term debt $ 100.0 $ — $100.0 $ — $ —Operating leases 893.0 58.2 116.4 115.5 602.9Purchase obligations 88.4 73.0 6.3 9.1 —Lines of credit 4.4 4.4 — — —

Total $1,085.8 $135.6 $222.7 $124.6 $602.9

The total principal amount of ending managed receivablessecuritized or held for investment or sale was as follows:

As of February 29 or 28(In millions) 2004 2003

Fixed-rate securitizations $1,647.9 $1,385.1Floating-rate securitizations

synthetically altered to fixed 551.8 473.2Floating-rate securitizations 0.7 0.8Held for investment(1) 29.4 16.0Held for sale(2) 18.8 3.6

Total $2,248.6 $1,878.7(1) The majority is held by a bankruptcy-remote special purpose entity.(2) Held by a bankruptcy-remote special purpose entity.

Interest Rate ExposureWe also have interest rate risk from changing interest ratesrelated to our outstanding debt. Substantially all of the debtis floating-rate debt based on LIBOR. A 100-basis pointincrease in market interest rates would not have had a materialeffect on our fiscal 2004 results of operations or cash flows.

C A U T I O N A R Y I N F O R M AT I O N A B O U TF O R W A R D - L O O K I N G S TAT E M E N T SThe provisions of the Private Securities Litigation Reform Actof 1995 provide companies with a “safe harbor” when makingforward-looking statements. This “safe harbor” encouragescompanies to provide prospective information about theircompanies without fear of litigation. The company wishes totake advantage of the “safe harbor” provisions of the Act.Company statements that are not historical facts, includingstatements about management’s expectations for fiscal 2005and beyond, are forward-looking statements and involvevarious risks and uncertainties.

Forward-looking statements are estimates and projectionsreflecting our judgment and involve a number of risks anduncertainties that could cause actual results to differ materiallyfrom those suggested by the forward-looking statements.Although we believe that the estimates and projectionsreflected in the forward-looking statements are reasonable, ourexpectations may prove to be incorrect. Investors are cautionednot to place undue reliance on any forward-lookingstatements, which are based on current expectations.Important factors that could cause actual results to differmaterially from estimates or projections contained in ourforward-looking statements include:■ In the normal course of business, we are subject to changes

in general U.S. or regional U.S. economic conditionsincluding, but not limited to, consumer credit availability,consumer credit delinquency and default rates, interestrates, inflation, personal discretionary spending levels, andconsumer sentiment about the economy in general. Anysignificant changes in economic conditions could adverselyaffect consumer demand and increase costs resulting inlower profitability for the company.

■ The company operates in a highly competitive industry andnew entrants to the industry could result in increasedwholesale costs for used vehicles and lower-than-expectedvehicle sales and margins.

■ Any significant changes in retail prices for used and new vehicles could result in lower sales and margins for the company.

■ A reduction in the availability or access to sources ofinventory would adversely affect the company’s business.

■ Should excess inventory develop, the inability to liquidateexcess inventory at prices that allow the company to meet itsmargin targets or to recover its costs would adversely affectthe company’s profitability.

■ The ability to attract and retain an effective managementteam in a dynamic environment and the availability of asuitable work force is vital to the company’s ability tomanage and support its service-driven operating strategies.The inability to attract such a work-force team or asignificant increase in payroll market costs would adverselyaffect the company’s profitability.

■ Changes in the availability or cost of capital and workingcapital financing, including the availability of long-termfinancing to support development of the company and theavailability of securitization financing, could adversely affectthe company’s growth and operating strategies.

■ A decrease in the availability of appropriate real estatelocations for expansion would limit the expansion of thecompany’s store base and the company’s future operatingresults.

■ The occurrence of weather events adversely affecting trafficat our retail locations could negatively impact the company’soperating results.

■ The occurrence of certain material events including naturaldisasters, acts of terrorism, the outbreak of war or othersignificant national or international events could adverselyaffect the company’s operating results.

■ The imposition of new restrictions or regulationsregarding the sale of products and/or services that thecompany sells, changes in tax or environmental rules andregulations applicable to the company or our competitors,or any failure to comply with such laws or any adversechange in such laws could increase costs and affect thecompany’s profitability.

■ We are subject to various litigation matters, which, if theoutcomes in any significant matters are adverse, couldnegatively affect the company’s business.

C A R M A X 2 0 0 4 2 7

2 8 C A R M A X 2 0 0 4

Years Ended February 29 or 28(In thousands except per share data) 2004 %(1) 2003 %(1) 2002 %(1)

SALES AND OPERATING REVENUES:

Used vehicle sales $3,470,615 75.5 $2,912,082 73.4 $2,497,150 70.7New vehicle sales 515,383 11.2 519,835 13.1 559,943 15.8Wholesale vehicle sales 440,571 9.6 366,589 9.2 325,552 9.2Other sales and revenues 171,122 3.7 171,438 4.3 151,114 4.3

NET SALES AND OPERATING REVENUES 4,597,691 100.0 3,969,944 100.0 3,533,759 100.0

Cost of sales 4,026,803 87.6 3,501,705 88.2 3,114,366 88.1

GROSS PROFIT 570,888 12.4 468,239 11.8 419,393 11.9

CARMAX AUTO FINANCE INCOME (NOTES 3 AND 4) 84,963 1.8 82,399 2.1 66,473 1.9

Selling, general, and administrative expenses (NOTE 2) 468,374 10.2 392,417 9.9 334,464 9.5Gain on franchise dispositions, net 2,327 0.1 — — — —Interest expense (NOTE 9) 1,137 — 2,261 0.1 4,958 0.1Interest income 683 — 737 — 12 —

Earnings before income taxes 189,350 4.1 156,697 3.9 146,456 4.1Provision for income taxes (NOTE 7) 72,900 1.6 61,895 1.6 55,654 1.6

NET EARNINGS $ 116,450 2.5 $ 94,802 2.4 $ 90,802 2.6

Weighted average common shares (NOTE 11):

Basic 103,503 102,983 102,039Diluted 105,628 104,570 104,022

NET EARNINGS PER SHARE (NOTE 11):

Basic $ 1.13 $ 0.92 $ 0.89Diluted $ 1.10 $ 0.91 $ 0.87

(1) Percents are calculated as a percentage of net sales and operating revenues and may not equal totals due to rounding.

C O N S O L I D A T E D S T A T E M E N T S O F E A R N I N G S

See accompanying notes to consolidated financial statements.

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At February 29 or 28(In thousands except share data) 2004 2003

ASSETS

CURRENT ASSETS:

Cash and cash equivalents (NOTE 2) $ 61,643 $ 34,615Accounts receivable, net 72,358 56,449Automobile loan receivables held for sale (NOTE 4) 18,781 3,579Retained interests in securitized receivables (NOTE 4) 145,988 135,016Inventory 466,061 466,450Prepaid expenses and other current assets 8,650 12,636

TOTAL CURRENT ASSETS 773,481 708,745

Property and equipment, net (NOTE 6) 244,064 187,158Deferred income taxes (NOTE 7) 185 —Other assets 19,287 21,714

TOTAL ASSETS $1,037,017 $917,617

LIABILITIES AND SHAREHOLDERS’ EQUITY

CURRENT LIABILITIES:

Accounts payable $ 145,517 $117,587Accrued expenses and other current liabilities 55,674 44,682Accrued income taxes 4,050 —Deferred income taxes (NOTE 7) 32,711 29,783Short-term debt (NOTE 9) 4,446 56,051

TOTAL CURRENT LIABILITIES 242,398 248,103

Long-term debt, excluding current installments (NOTE 9) 100,000 100,000Deferred revenue and other liabilities 13,866 10,904Deferred income taxes (NOTE 7) — 4,041

TOTAL LIABILITIES 356,264 363,048

SHAREHOLDERS’ EQUITY (NOTES 1 AND 10):

Common stock, $0.50 par value; 350,000,000 shares authorized;103,778,461 and 103,083,047 shares issued and outstanding at February 29, 2004, and February 28, 2003, respectively 51,889 51,542

Capital in excess of par value 482,132 472,745Retained earnings 146,732 30,282

TOTAL SHAREHOLDERS’ EQUITY 680,753 554,569

Commitments and contingent liabilities (NOTES 1, 8, 9, 12, AND 13) — —

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY $1,037,017 $917,617

C O N S O L I D A T E D B A L A N C E S H E E T S


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Years Ended February 29 or 28(In thousands) 2004 2003 2002

OPERATING ACTIVITIES:

Net earnings $ 116,450 $ 94,802 $ 90,802Adjustments to reconcile net earnings to net

cash provided by operating activities:Depreciation and amortization 16,181 14,873 16,340Amortization of restricted stock awards 122 77 100(Gain) loss on disposition of assets (1,462) 30 —Provision for deferred income taxes (1,298) 8,880 3,162Changes in operating assets and liabilities:

(Increase) decrease in accounts receivable, net (15,909) (6,008) 7,232(Increase) decrease in automobile loan receivables held for sale (15,202) (1,435) 704Increase in retained interests in securitized receivables (10,972) (14,333) (46,542)Decrease (increase) in inventory 389 (67,366) (51,947)Decrease (increase) in prepaid expenses and other current assets 3,986 (10,571) 241Decrease (increase) in other assets 4,647 (845) 1,639Increase in accounts payable, accrued expenses and other

current liabilities, and accrued income taxes 48,570 51,375 19,330Increase in deferred revenue and other liabilities 2,962 2,488 1,580

NET CASH PROVIDED BY OPERATING ACTIVITIES 148,464 71,967 42,641

INVESTING ACTIVITIES:

Purchases of property and equipment (181,338) (122,032) (41,417)Proceeds from sales of property and equipment 107,493 41,621 98,965

NET CASH (USED IN) PROVIDED BY INVESTING ACTIVITIES (73,845) (80,411) 57,548

FINANCING ACTIVITIES:

(Decrease) increase in short-term debt, net (51,605) 46,211 8,853Issuance of long-term debt — 100,000 —Payments on long-term debt — (78,608) (112,600)Equity issuances, net 4,014 570 (1,958)Special dividend paid — (28,400) —

NET CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES (47,591) 39,773 (105,705)

Increase (decrease) in cash and cash equivalents 27,028 31,329 (5,516)Cash and cash equivalents at beginning of year 34,615 3,286 8,802

CASH AND CASH EQUIVALENTS AT END OF YEAR $ 61,643 $ 34,615 $ 3,286

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION

Cash paid during the year for:Interest $ 4,695 $ 3,862 $ 5,336Income taxes $ 59,987 $ 49,215 $ 42,332

C O N S O L I D A T E D S T A T E M E N T S O F C A S H F L O W S


C A R M A X 2 0 0 4 3 1

Common Capital inShares Common Excess of Retained Parent’s

(In thousands) Outstanding Stock Par Value Earnings Equity Total

BALANCE AT MARCH 1, 2001 — $ — $ — $ — $ 391,503 $391,503

Net earnings — — — — 90,802 90,802Equity issuances, net — — — — 3,174 3,174

BALANCE AT FEBRUARY 28, 2002 — — — — 485,479 485,479

Net earnings — — — 30,282 64,520 94,802Equity issuances, net — — — — 2,589 2,589Special dividend — — — — (28,400) (28,400)Recapitalization due to separation 103,014 51,507 472,681 — (524,188) —Exercise of common stock options 39 20 177 — — 197Shares purchased for employee stock

purchase plan — — (213) — — (213)Shares issued under stock incentive plans 30 15 408 — — 423Tax benefit from stock issued — — 12 — — 12Unearned compensation-restricted stock — — (320) — — (320)

BALANCE AT FEBRUARY 28, 2003 103,083 51,542 472,745 30,282 — 554,569

Net earnings — — — 116,450 — 116,450Exercise of common stock options 693 346 4,176 — — 4,522Shares purchased for employee stock

purchase plan — — (599) — — (599)Shares issued under stock incentive plans 3 2 95 — — 97Shares cancelled upon reacquisition

by the company (1) (1) (13) — — (14)Tax benefit from stock issued — — 5,598 — — 5,598Unearned compensation-restricted stock — — 130 — — 130

BALANCE AT FEBRUARY 29, 2004 103,778 $51,889 $482,132 $146,732 $ — $680,753

C O N S O L I D A T E D S T A T E M E N T S O F S H A R E H O L D E R S ’ E Q U I T Y


3 2 C A R M A X 2 0 0 4

B A C K G R O U N D A N D B A S I S O FP R E S E N TAT I O N

CarMax, Inc. (“CarMax” and “the company”), including itswholly owned subsidiaries, is the leading specialty retailer ofused cars and light trucks in the United States. CarMax wasthe first used vehicle retailer to offer a large selection ofquality used vehicles at low, “no-haggle” prices using acustomer-friendly sales process in an attractive, modern salesfacility. CarMax also sells new vehicles under various franchiseagreements. CarMax provides its customers with a full rangeof related services, including the financing of vehiclepurchases through its own finance operation, CarMax AutoFinance (“CAF”), and third-party lenders; the sale ofextended warranties; and vehicle repair service.

CarMax was formerly a subsidiary of Circuit City Stores,Inc. (“Circuit City”). Prior to October 1, 2002, Circuit Cityhad two common stock series, the Circuit City Stores, Inc.—Circuit City Group (“Circuit City Group”) common stockand the Circuit City Stores, Inc.—CarMax Group (“CarMaxGroup”) common stock, which was intended to trackseparately the performance of the CarMax business. OnOctober 1, 2002, the CarMax business was separated fromCircuit City through a tax-free transaction in which eachshare of CarMax Group common stock was exchanged for oneshare of CarMax, Inc. common stock. In addition, eachholder of Circuit City Group common stock received adistribution of a 0.313879 share of CarMax, Inc. commonstock for each Circuit City Group share. As a result of theseparation, all of the businesses, assets, and liabilities of theCarMax Group are held in CarMax, Inc., an independent,separately traded public company.

In conjunction with the separation, all outstandingCarMax Group stock options and restricted stock werereplaced with CarMax, Inc. stock options and restrictedstock with the same terms and conditions, exercise prices,and restrictions as the CarMax Group stock options andrestricted stock they replaced.

At the separation date, Circuit City and CarMax executeda transition services agreement and a tax allocation agreement.In the transition services agreement, Circuit City agreed toprovide to CarMax services including human resources,payroll, benefits administration, tax services, computer centersupport, and telecommunications. The agreement specifiedinitial service periods ranging from six to twenty-fourmonths, with varying renewal options. For fiscal 2005,Circuit City will provide computer center support andtelecommunication services for CarMax pursuant to thisagreement. The tax allocation agreement provided that thepre-separation taxes attributable to the business of each partywould be borne solely by that party.

1S U M M A R Y O F S I G N I F I C A N TA C C O U N T I N G P O L I C I E S

(A) Principles of Consol idat ionThe consolidated financial statements include the accounts ofCarMax and its wholly owned subsidiaries. All significantintercompany balances and transactions have been eliminatedin consolidation.

(B) Cash and Cash EquivalentsCash equivalents of $48.9 million and $29.6 million atFebruary 29, 2004, and February 28, 2003, respectively,consisted of highly liquid debt securities with originalmaturities of three months or less. Included in cash equivalentsat February 29, 2004, and February 28, 2003, were restrictedcash deposits of $13.0 million and $11.5 million, respectively,which were associated with certain insurance deductibles.Additional restricted cash related to securitized auto loanreceivables at February 29, 2004, and February 28, 2003, were$6.4 million and $2.4 million, respectively.

(C) Securit izat ionsThe company uses a securitization program to fundsubstantially all of the automobile loan receivables originatedby CAF. The company sells the automobile loan receivables toa wholly owned, bankruptcy-remote, special purpose entitythat transfers an undivided interest in the receivables to a groupof third-party investors. This program is referred to as thewarehouse facility.

The company periodically uses public securitizations torefinance the receivables previously securitized through thewarehouse facility. In a public securitization, a pool ofautomobile loan receivables is sold to a bankruptcy-remote,special purpose entity that in turn transfers the receivables to aspecial purpose securitization trust.

The transfers of receivables are accounted for as sales inaccordance with Statement of Financial Accounting Standards(“SFAS”) No. 140, “Accounting for Transfers and Servicing ofFinancial Assets and Extinguishments of Liabilities.” Thecompany retains various interests in the automobile loanreceivables that it securitizes. The retained interests presentedon the company’s consolidated balance sheets include thepresent value of the expected residual cash flows generated bythe securitized receivables, the restricted cash on deposit invarious reserve accounts, and an undivided ownership interestin the receivables securitized through the warehouse facility andcertain public securitizations. Retained interests are carried atfair value and changes in fair value are included in earnings. SeeNotes 3 and 4 for additional discussion on securitizations.

2

N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S

C A R M A X 2 0 0 4 3 3

(D) Fair Value of Financial InstrumentsThe carrying value of the company’s cash and cash equivalents,receivables including automobile loan receivables, accountspayable, short-term borrowings, and long-term debtapproximates fair value. The company’s retained interests insecuritized receivables and derivative financial instruments arerecorded on the consolidated balance sheets at fair value.

(E) Trade Accounts ReceivableTrade accounts receivable, net of an allowance for doubtfulaccounts, include certain amounts due from finance companiesand customers, as well as from manufacturers for incentives andwarranty reimbursements, and for other miscellaneousreceivables. The estimate for doubtful accounts is based onhistorical experience and trends.

(F) Inventor yInventory is comprised primarily of vehicles held for sale orundergoing reconditioning and is stated at the lower of cost ormarket. Vehicle inventory cost is determined by specificidentification. Parts and labor used to recondition vehicles, aswell as transportation and other incremental expenses associatedwith acquiring and reconditioning vehicles, are included ininventory. Certain manufacturer incentives and rebates for newcar inventory, including holdbacks, are recognized as a reductionto new car inventory when the company purchases the vehicles.Volume-based incentives are recognized as a reduction to newcar inventory cost when achievement of volume thresholds aredetermined to be probable.

(G) Property and EquipmentProperty and equipment is stated at cost less accumulateddepreciation and amortization. Depreciation and amortizationare calculated using the straight-line method over the assets’estimated useful lives.

(H) Computer Software CostsExternal direct costs of materials and services used in thedevelopment of internal-use software and payroll and payroll-related costs for employees directly involved in thedevelopment of internal-use software are capitalized. Amountscapitalized are amortized on a straight-line basis over a periodof five years.

( I) Goodwil l and Intangible AssetsSFAS No. 142, “Goodwill and Other Intangible Assets,”requires that goodwill and intangible assets with indefiniteuseful lives not be amortized, but rather tested for impairmentat least annually. As of March 1, 2002, the companyperformed the required transition impairment tests ofgoodwill and other intangible assets and determined that noimpairment existed. Additionally, as of February 29, 2004,and February 28, 2003, no impairment of goodwill orintangible assets resulted from the annual impairment tests.Prior to March 1, 2002, goodwill and other intangibles with

indefinite useful lives were amortized on a straight-line basisover 15 years. The carrying amount of goodwill and otherintangibles was $16.0 million as of February 29, 2004, and$21.7 million as of February 28, 2003.

( J) Def ined Benef it Retirement Plan and Insurance Liabi l i t ies

Defined benefit retirement plan obligations and insuranceliabilities are included in accrued expenses and other currentliabilities on the company’s consolidated balance sheets. Thedefined benefit retirement plan obligations are determined byindependent actuaries using a number of assumptions providedby the company. Key assumptions used to measure the planobligations include the discount rate, the rate of salaryincreases, and the estimated future return on plan assets.Insurance liability estimates for workers’ compensation, generalliability, and employee-related health care benefits aredetermined by considering historical claims experience,demographic factors, and other actuarial assumptions.

(K) Impairment or Disposal of Long-Lived AssetsThe company reviews long-lived assets for impairment whencircumstances indicate the carrying amount of an asset may notbe recoverable. Impairment is recognized when the sum ofundiscounted estimated future cash flows expected to resultfrom the use of the asset is less than the carrying value.

(L) Store Opening ExpensesCosts relating to store openings, including preopening costs,are expensed as incurred.

(M) Income TaxesDeferred income taxes reflect the impact of temporarydifferences between the amounts of assets and liabilitiesrecognized for financial reporting purposes and the amountsrecognized for income tax purposes, measured by applyingcurrently enacted tax laws. A deferred tax asset is recognized ifit is more likely than not that a benefit will be realized.

(N) Revenue Recognit ionThe company recognizes revenue when the earnings process iscomplete, generally either at the time of sale to a customer orupon delivery to a customer. As part of its customer servicestrategy, the company guarantees the vehicles it sells with a 5-day or 250-mile, money-back guarantee. If a customer returnsthe vehicle purchased within the limits of the guarantee, thecompany will refund the customer’s money. A reserve for vehiclereturns is recorded based on historical experience and trends.

The company sells extended warranties on behalf ofunrelated third parties. These warranties have terms ofcoverage from 12 to 72 months. Because these third partiesare the primary obligors under these warranties, commissionrevenue is recognized at the time of sale, net of a provision forestimated customer returns of the warranties. The reserve forreturns is based on historical experience and trends.

3 4 C A R M A X 2 0 0 4

(O) Advert is ing ExpensesAll advertising costs are expensed as incurred. Advertisingexpense, which is included in selling, general, andadministrative expenses in the accompanying consolidatedstatements of earnings, amounted to $62.4 million in fiscal2004, $52.4 million in fiscal 2003, and $47.3 million in fiscal2002. Advertising expense was 1.4% of net sales and operatingrevenues for fiscal 2004 and 1.3% for fiscal 2003 and 2002.

(P) Net Earnings Per ShareBasic net earnings per share is computed by dividing netearnings by the weighted average number of shares of commonstock outstanding. Diluted net earnings per share is computedby dividing net earnings by the sum of the weighted averagenumber of shares of common stock outstanding and dilutivepotential common stock.

(Q) Stock-Based CompensationThe company accounts for its stock-based compensation plansunder the recognition and measurement principles of AccountingPrinciples Board Opinion No. 25, “Accounting for Stock Issuedto Employees,” and related interpretations. Under this opinionand related interpretations, compensation expense is recorded onthe date of grant and amortized over the period of service only ifthe market value of the underlying stock on the grant date exceedsthe exercise price. No stock option-based employee compensationcost is reflected in net earnings, as options granted under thoseplans had exercise prices equal to the market value of theunderlying common stock on the date of grant. The followingtable illustrates the effect on net earnings and net earnings pershare as if the fair-value-based method of accounting had beenapplied to all outstanding stock awards in each reported period:

Years Ended February 29 or 28(In thousands except per share data) 2004 2003 2002

Net earnings, as reported $116,450 $94,802 $90,802

Total additional stock-based compensation expenses determined under the fair-value-based method for all awards, net of related tax effects 6,759 4,391 1,559

Pro forma net earnings $109,691 $90,411 $89,243

Earnings per share:Basic, as reported $ 1.13 $ 0.92 $ 0.89Basic, pro forma $ 1.06 $ 0.88 $ 0.87

Diluted, as reported $ 1.10 $ 0.91 $ 0.87Diluted, pro forma $ 1.04 $ 0.86 $ 0.86

The pro forma effect on fiscal 2004 may not be representativeof the pro forma effects on net earnings and net earnings pershare for future years.

For the purpose of computing the pro forma amountsindicated above, the fair value of each option on the date of grantwas estimated using the Black-Scholes option-pricing model. Theweighted average assumptions used in the model were as follows:


Expected dividend yield — — —Expected stock volatility 78% 76% 79%Risk-free interest rates 3% 4% 5%Expected lives (in years) 5 5 4

Using these assumptions in the Black-Scholes model, theweighted average fair value of options granted was $9 per sharein fiscal 2004, $17 per share in fiscal 2003, and $3 per share infiscal 2002.

(R) Derivat ive Financial InstrumentsIn connection with securitization activities through thewarehouse facility, the company enters into interest rate swapagreements to manage exposure to interest rates and to moreclosely match funding costs to the use of funding. Thecompany recognizes the interest rate swaps as either assets orliabilities on the consolidated balance sheets at fair value withchanges in fair value included in earnings as a component ofCarMax Auto Finance income.

(S) Risks and Uncertaint iesCarMax retails used and new vehicles. The diversity of thecompany’s customers and suppliers reduces the risk that a severeimpact will occur in the near term as a result of changes in itscustomer base, competition, or sources of supply. However,management cannot assure that unanticipated events will nothave a negative impact on the company.

The preparation of financial statements in conformity withaccounting principles generally accepted in the United States ofAmerica requires management to make estimates andassumptions that affect the reported amounts of assets, liabilities,revenues and expenses, and the disclosure of contingent assetsand liabilities. Actual results could differ from those estimates.

(T) Reclass i f icat ionsCertain prior year amounts have been reclassified to conform tothe current year’s presentation.

C A R M A X 2 0 0 4 3 5

C A R M A X A U T O F I N A N C E I N C O M E

The company’s finance operation, CAF, originates automobileloans to prime-rated customers at competitive market rates ofinterest. The company sells substantially all of the loans itoriginates each month in a securitization transaction discussed inNote 4. The majority of the profit contribution from CAF isgenerated by the spread between the interest rate charged to thecustomer and the cost of funds. A gain, recorded at the time of thesecuritization transaction, results from recording a receivable equalto the present value of the expected residual cash flows generatedby the securitized receivables. The cash flows are calculated takinginto account expected prepayment and default rates.

CarMax Auto Finance income was as follows:


Gains on sales of loans $65.1 $68.2 $56.4

Other income:Servicing fee income 21.8 17.3 14.0Interest income 16.0 11.5 7.7

Total other income 37.8 28.8 21.7

Direct expenses:CAF payroll and

fringe benefit expense 8.2 7.0 5.7Other direct CAF expenses 9.7 7.6 5.9

Total direct expenses 17.9 14.6 11.6

CarMax Auto Finance income $85.0 $82.4 $66.5

CarMax Auto Finance income does not include anyallocation of indirect costs or income. The company presentsthis information on a direct basis to avoid making arbitrarydecisions regarding the indirect benefit or costs that could beattributed to CAF. Examples of indirect costs not included areretail store expenses, retail financing commissions, andcorporate expenses such as human resources, administrativeservices, marketing, information systems, accounting, legal,treasury, and executive payroll.

S E C U R I T I Z AT I O N S

The company uses a securitization program to fundsubstantially all of the automobile loan receivables originatedby CAF. The company sells the automobile loan receivables toa wholly owned, bankruptcy-remote, special purpose entitythat transfers an undivided interest in the receivables to a groupof third-party investors. The special purpose entity and

4

3 investors have no recourse to the company’s assets. Thecompany’s risk is limited to the retained interests on thecompany’s consolidated balance sheets. The investors issuecommercial paper supported by the transferred receivables, andthe proceeds from the sale of the commercial paper are used topay for the securitized receivables. This program is referred toas the warehouse facility.

The company periodically uses public securitizations torefinance the receivables previously securitized through thewarehouse facility. In a public securitization, a pool ofautomobile loan receivables is sold to a bankruptcy-remote,special purpose entity that in turn transfers the receivables to aspecial purpose securitization trust. The securitization trustissues asset-backed securities, secured or otherwise supportedby the transferred receivables, and the proceeds from the sale ofthe securities are used to pay for the securitized receivables. Theearnings impact of refinancing receivables in a publicsecuritization has not been material to the operations of thecompany. However, because securitization structures couldchange from time to time, this may not be representative of thepotential impact of future securitizations.

The transfers of receivables are accounted for as sales inaccordance with SFAS No. 140. When the receivables aresecuritized, the company recognizes a gain or loss on the sale ofthe receivables as described in Note 3.


Net loans originated $1,407.6 $1,189.0 $941.0Loans sold $1,390.2 $1,185.9 $938.5Gains on sales of loans $ 65.1 $ 68.2 $ 56.4Gains on sales of loans as a

percentage of loans sold 4.7% 5.8% 6.0%

Retained InterestsThe company retains various interests in the automobile loanreceivables that it securitizes. The retained interests, presentedas current assets on the company’s consolidated balance sheets,serve as a credit enhancement for the benefit of the investors inthe securitized receivables. These retained interests include thepresent value of the expected residual cash flows generated bythe securitized receivables, or “interest-only strip receivables,”the restricted cash on deposit in various reserve accounts, andan undivided ownership interest in the receivables securitizedthrough the warehouse facility and certain publicsecuritizations, or “required excess receivables,” as described

3 6 C A R M A X 2 0 0 4

below. The cash reserves and excess receivables are generally 2%to 4% of managed receivables. The special purpose entities andthe investors have no recourse to the company’s assets. Thecompany’s risk is limited to the retained interests on thecompany’s consolidated balance sheets. The fair value of theretained interests may fluctuate depending on the performanceof the securitized receivables.

The fair value of retained interests was $146.0 million as ofFebruary 29, 2004, and $135.0 million as of February 28, 2003.The retained interests had a weighted average life of 1.5 years asof February 29, 2004, and 1.6 years as of February 28, 2003. Asdefined in SFAS No. 140, the weighted average life in periods(for example, months or years) of pre-payable assets is calculatedby multiplying the principal collections expected in each futureperiod by the number of periods until that future period,summing those products, and dividing the sum by the initialprincipal balance. The following is a detailed explanation of thecomponents of retained interests.

Interest-Only Strip Receivables. Interest-only stripreceivables represent the present value of residual cash flows thecompany expects to receive over the life of the securitizedreceivables. The value of these receivables is determined byestimating the future cash flows using management’sassumptions of key factors, such as finance charge income,default rates, prepayment rates, and discount rates appropriatefor the type of asset and risk. The value of interest-only stripreceivables may be affected by external factors, such as changesin the behavior patterns of customers, changes in the strengthof the economy, and developments in the interest rate markets;therefore, actual performance may differ from theseassumptions. Management evaluates the performance of thereceivables relative to these assumptions on a regular basis. Anyfinancial impact resulting from a change in performance isrecognized in earnings in the period in which it occurs.

Restricted Cash. Restricted cash represents amounts ondeposit in various reserve accounts established for the benefitof the securitization investors. The amounts on deposit in thereserve accounts are used to pay various amounts, includingprincipal and interest to investors, in the event that the cashgenerated by the securitized receivables in a given period isinsufficient to pay those amounts. In general, each of thecompany’s securitizations requires that an amount equal to aspecified percentage of the initial receivables balance bedeposited in a reserve account on the closing date and that anyexcess cash generated by the receivables be used to fund thereserve account to the extent necessary to maintain therequired amount. If the amount on deposit in the reserveaccount exceeds the required amount, an amount equal to thatexcess is released through the special purpose entity to thecompany. In the public securitizations, the amount required tobe on deposit in the reserve account must equal or exceed aspecified floor amount. The reserve account remains at thefloor amount until the investors are paid in full, at which time

the remaining reserve account balance is released through thespecial purpose entity to the company. The amount requiredto be maintained in the public securitization reserve accountsmay increase depending upon the performance of thesecuritized receivables. The amount on deposit in the restrictedcash accounts was $34.8 million as of February 29, 2004, and$33.3 million as of February 28, 2003.

Required Excess Receivables. The warehouse facility andcertain public securitizations require that the total value of thesecuritized receivables exceed, by a specified amount, theprincipal amount owed to the investors. The required excessreceivables balance represents this specified amount. Any cashflows generated by the required excess receivables are used, ifneeded, to make payments to the investors. The unpaidprincipal balance related to the required excess receivables was$28.8 million as of February 29, 2004, and $13.4 million as ofFebruary 28, 2003.

Key Assumptions Used in Measuring RetainedInterests and Sensit iv ity Analys isThe following table shows the key economic assumptions usedin measuring the fair value of the retained interests at February 29,2004, and a sensitivity analysis showing the hypothetical effecton the retained interests if there were unfavorable variationsfrom the assumptions used. Key economic assumptions atFebruary 29, 2004, are not materially different fromassumptions used to measure the fair value of retained interestsat the time of securitization. These sensitivities are hypotheticaland should be used with caution. In this table, the effect of avariation in a particular assumption on the fair value of theretained interests is calculated without changing any otherassumption; in actual circumstances, changes in one factor mayresult in changes in another, which might magnify or counteractthe sensitivities.

Impact on Impact on Fair Value of Fair Value of

Assumptions 10% Adverse 20% Adverse(In millions) Used Change Change

Prepayment rate 1.45%–1.55% $5.4 $10.5Cumulative default rate 2.00%–2.50% $4.1 $ 8.1Annual discount rate 12.0% $2.1 $ 4.2

Prepayment Rate. The company uses the AbsolutePrepayment Model or “ABS” to estimate prepayments. Thismodel assumes a rate of prepayment each month relative to theoriginal number of receivables in a pool of receivables. ABSfurther assumes that all the receivables are the same size andamortize at the same rate and that each receivable in eachmonth of its life will either be paid as scheduled or prepaid infull. For example, in a pool of receivables originally containing10,000 receivables, a 1% ABS rate means that 100 receivablesprepay each month.

Cumulative Default Rate. Cumulative default rate or“static pool” net losses are calculated by dividing the totalprojected future credit losses of a pool of receivables by theoriginal pool balance.

C A R M A X 2 0 0 4 3 7

Continuing Involvement with Securitized ReceivablesThe company continues to manage the automobile loanreceivables that it securitizes. The company receives servicingfees of approximately 1% of the outstanding principal balanceof the securitized receivables. The servicing fees specified in thesecuritization agreements adequately compensate the companyfor servicing the securitized receivables. Accordingly, noservicing asset or liability has been recorded. The company is atrisk for the retained interests in the securitized receivables. If thesecuritized receivables do not perform as originally projected,the value of the retained interests would be impacted. Theassumptions used to value the retained interests, as well as asensitivity analysis, are detailed in the “Key Assumptions Usedin Measuring Retained Interests and Sensitivity Analysis” sectionof this footnote. Supplemental information about the managedreceivables is shown in the following tables:

As of February 29 or 28(In millions) 2004 2003 2002

Loans securitized $2,200.4 $1,859.1 $1,489.4Loans held for sale

or investment 48.2 19.6 13.9

Ending managed receivables $2,248.6 $1,878.7 $1,503.3

Accounts 31+ days past due $ 31.4 $ 27.6 $ 22.3Past due accounts as a

percentage of ending managed receivables 1.40% 1.47% 1.48%


Average managedreceivables $2,099.4 $1,701.0 $1,393.7

Credit losses on managed receivables $ 21.1 $ 17.5 $ 12.9

Credit losses as a percentage of average managed receivables 1.01% 1.03% 0.93%

Selected Cash Flows from Securit ized ReceivablesThe table below summarizes certain cash flows received fromand paid to the automobile loan securitizations:


• Proceeds from new securitizations $1,185.5 $1,018.7 $755.7

• Proceeds from collections reinvested in revolving period securitizations $ 514.9 $ 468.9 $452.3

• Servicing fees received $ 21.5 $ 17.0 $ 13.8• Other cash flows received

from retained interests:Interest-only strip receivables $ 74.1 $ 65.4 $ 48.2Cash reserve releases, net $ 16.6 $ 25.3 $ 15.8

Proceeds from New Securitizations. Proceeds from newsecuritizations represent receivables newly securitized throughthe warehouse facility during the period. Receivables initiallysecuritized through the warehouse facility that are periodicallyrefinanced in public securitizations are not considered newsecuritizations for this table.

Proceeds from Collections. Proceeds from collectionsreinvested in revolving period securitizations representprincipal amounts collected on receivables securitized throughthe warehouse facility, which are used to fund new originations.

Servicing Fees. Servicing fees received represent cash feespaid to the company to service the securitized receivables.

Other Cash Flows Received from Retained Interests. Othercash flows received from retained interests represent cashreceived by the company from securitized receivables otherthan servicing fees. It includes cash collected on interest-onlystrip receivables and amounts released to the company fromrestricted cash accounts.

Financial Covenants and Performance TriggersCertain securitization agreements include various financialcovenants and performance triggers, while other securitizationagreements, such as public securitizations with a senior-subordinated structure, do not include financial covenants orperformance triggers. For those agreements with financialcovenants and performance triggers, the company must meetfinancial covenants relating to minimum tangible net worth,maximum total liabilities to tangible net worth ratio, minimumtangible net worth to managed assets ratio, minimum currentratio, minimum cash balance or borrowing capacity, andminimum fixed charge coverage ratio. Certain securitizedreceivables must meet performance tests relating to portfolioyield, default rates, and delinquency rates. If these financialcovenants and/or performance tests are not met, in addition toother consequences, the company may be unable to continue tosecuritize receivables through the warehouse facility or it may beterminated as servicer under the securitizations. At February 29,2004, the company was in compliance with these financialcovenants, and the securitized receivables were in compliancewith these performance triggers.

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F I N A N C I A L D E R I V AT I V E S

The company enters into amortizing fixed-pay interest rateswaps relating to its automobile loan receivable securitizations.Swaps are used to better match funding costs to the fixed-ratereceivables being securitized by converting variable-ratefinancing costs in the warehouse facility to fixed-rateobligations. The company entered into twenty-two 40-monthamortizing interest rate swaps with initial notional amountstotaling approximately $1.21 billion in fiscal 2004, one 20-month and twelve 40-month amortizing interest rate swapswith initial notional amounts totaling approximately $1.05billion in fiscal 2003, and twelve 40-month amortizing interestrate swaps with initial notional amounts totaling approximately$854.0 million in fiscal 2002. The amortized notional amountof all outstanding swaps related to the automobile loanreceivable securitizations was approximately $551.8 million atFebruary 29, 2004, and $473.2 million at February 28, 2003.The fair value of swaps included in accounts payable totaled anet liability of $2.0 million at February 29, 2004, and $2.6million at February 28, 2003.

The market and credit risks associated with interest rateswaps are similar to those relating to other types of financialinstruments. Market risk is the exposure created by potentialfluctuations in interest rates. The company does not anticipatesignificant market risk from swaps as they are used on amonthly basis to match funding costs to the use of thefunding. Credit risk is the exposure to nonperformance ofanother party to an agreement. The company mitigates creditrisk by dealing with highly rated bank counterparties.

P R O P E R T Y A N D E Q U I P M E N T

Property and equipment, at cost, is summarized as follows:

As of February 29 or 28(In thousands) 2004 2003

Buildings (25 to 40 years) $ 30,985 $ 18,381Land 25,716 19,418Land held for sale 3,163 3,354Land held for development 3,580 8,021Construction in progress 116,639 91,938Furniture, fixtures, and equipment

(5 to 15 years) 103,787 86,129Leasehold improvements

(8 to 15 years) 29,427 21,029

313,297 248,270Less accumulated depreciation

and amortization 69,233 61,112

Property and equipment, net $244,064 $187,158

Land held for development represents land owned forfuture sites that are scheduled to open more than one yearbeyond the fiscal year reported.

6

5 I N C O M E TA X E S

The components of the provision for income taxes on netearnings were as follows:

Years Ended February 29 or 28(In thousands) 2004 2003 2002

Current:Federal $65,212 $47,600 $47,389State 8,986 5,415 5,103

Total 74,198 53,015 52,492

Deferred:Federal (1,180) 8,614 3,067State (118) 266 95

Total (1,298) 8,880 3,162

Provision for income taxes $72,900 $61,895 $55,654

The effective income tax rate differed from the federalstatutory income tax rate as follows:


Federal statutory income tax rate 35.0% 35.0% 35.0%

State and local income taxes, net of federal benefit 3.1 3.0 2.9

Non-deductible items 0.4 1.5 0.1

Effective income tax rate 38.5% 39.5% 38.0%

The tax effects of temporary differences that give rise to asignificant portion of the deferred tax assets and liabilitieswere as follows:


Deferred tax assets:Accrued expenses $ 9,048 $ 7,220Other 79 120

Total gross deferred tax assets 9,127 7,340

Deferred tax liabilities:Depreciation and amortization 5,224 5,748Securitized receivables 27,940 29,138Inventory 7,607 5,447Prepaid expenses 882 831

Total gross deferred tax liabilities 41,653 41,164

Net deferred tax liability $32,526 $33,824

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Based on the company’s historical and current pretaxearnings, management believes the amount of gross deferred taxassets will more likely than not be realized through futuretaxable income and future reversals of existing temporarydifferences; therefore, no valuation allowance is necessary.

R E T I R E M E N T P L A N S

The company has a noncontributory defined benefit pensionplan covering the majority of full-time employees who are atleast 21 years old and have completed one year of service. Thecost of the program is being funded currently. Plan benefitsgenerally are based on years of service and averagecompensation. The company also has an unfunded nonqualifiedplan (“restoration plan”) that restores retirement benefits forcertain senior executives who are affected by Internal RevenueCode limitations on benefits provided under the pension plan.The liabilities for these plans are included in accrued expensesand other current liabilities in the consolidated balance sheets.

Funding Policy. For the defined benefit pension plan, thecompany contributes amounts sufficient to meet minimumfunding requirements as set forth in the employee benefit andtax laws plus any additional amounts as the company maydetermine to be appropriate. The company expects to

8

contribute approximately $0.2 million to the pension plan infiscal 2005.

Projected Benefit Obligations. The projected benefitobligations are the present value of future benefits toemployees, including assumed salary increases. Changes inthe company’s projected benefit obligations are presented inTable 1.

Assets. Assets used in calculating the funded status aremeasured at current market values. The restoration plan isexcluded since it is unfunded. Changes in the market value ofthe company’s pension plan assets were as follows:

Years Ended February 29 or 28Pension Plan

(In thousands) 2004 2003

Change in plan assets:Fair value of plan assets at

beginning of year $ 5,676 $ 5,008Actual return on plan assets 2,564 (1,095)Adjustment for separation 606 (478)Employer contributions 7,785 2,343Benefits paid (227) (102)

Fair value of plan assets at end of year $16,404 $ 5,676

TABLE 1

Years Ended February 29 or 28Pension Plan Restoration Plan Total

(In thousands) 2004 2003 2004 2003 2004 2003

Change in projected benefit obligation:Benefit obligation at beginning of year $24,555 $14,868 $2,031 $1,583 $26,586 $16,451Service cost 5,529 4,021 231 197 5,760 4,218Interest cost 1,679 1,104 126 99 1,805 1,203Plan amendments — 367 — (220) — 147Actuarial loss 3,074 4,297 1,208 372 4,282 4,669Adjustment for separation 1,308 — — — 1,308 —Benefits paid (227) (102) — — (227) (102)

Projected benefit obligation at end of year $35,918 $24,555 $3,596 $2,031 $39,514 $26,586

Funded Status. The funded status represents the difference between the projected benefit obligations and the market value ofthe assets. The components of the funded status of the retirement plans were as follows:

As of February 29 or 28Pension Plan Restoration Plan Total

(In thousands) 2004 2003 2004 2003 2004 2003

Reconciliation of funded status:Funded status $(19,514) $(18,879) $(3,596) $(2,031) $(23,110) $(20,910)Unrecognized actuarial loss 10,574 13,339 2,024 870 12,598 14,209Adjustment for separation — (4,055) — — — (4,055)Unrecognized prior service

benefit/(cost) 294 331 (1) (2) 293 329

Net amount recognized $ (8,646) $ (9,264) $(1,573) $(1,163) $(10,219) $(10,427)

Additional Information.

As of February 29 or 28Pension Plan Restoration Plan Total

(In thousands) 2004 2003 2004 2003 2004 2003

Projected benefit obligation $35,918 $24,555 $3,596 $2,031 $39,514 $26,586Accumulated benefit obligation $21,991 $12,858 $1,553 $ 815 $23,544 $13,673Fair value of plan assets $16,404 $ 5,676 — — $16,404 $ 5,676

Expense. The components of net pension expense were as follows:

Years Ended February 29 or 28Pension Plan Restoration Plan Total

(In thousands) 2004 2003 2002 2004 2003 2002 2004 2003 2002

Service cost $5,529 $4,021 $2,549 $231 $197 $128 $5,760 $4,218 $2,677Interest cost 1,679 1,104 588 126 99 49 1,805 1,203 637Expected return on plan assets (892) (617) (424) — — — (892) (617) (424)Amortization of prior year service cost 37 35 (2) — — 31 37 35 29Amortization of transitional asset — — (3) — — — — — (3)Recognized actuarial loss 647 194 203 53 32 9 700 226 212

Net pension expense $7,000 $4,737 $2,911 $410 $328 $217 $7,410 $5,065 $3,128

Assumptions. Assumptions used to determine benefit obligations were as follows:

Years Ended February 29 or 28Pension Plan Restoration Plan

2004 2003 2002 2004 2003 2002

Weighted average discount rate 6.00% 6.50% 7.25% 6.00% 6.50% 7.25%Rate of increase in compensation levels 5.00% 6.00% 7.00% 7.00% 6.00% 7.00%

Assumptions used to determine net pension expense were as follows:

As of February 29 or 28Pension Plan Restoration Plan

2004 2003 2002 2004 2003 2002

Weighted average discount rate 6.50% 7.25% 7.50% 6.50% 7.25% 7.50%Expected rate of return on plan assets 9.00% 9.00% 9.00% — — —Rate of increase in compensation levels 6.00% 7.00% 6.00% 6.00% 7.00% 6.00%

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To determine the expected long-term rate of return onpension plan assets, the company considers the current andexpected asset allocations, as well as historical and expectedreturns on various categories of plan assets. The companyapplies the expected rate of return to a market-related value ofassets, which reduces the underlying variability in assets towhich the expected return is applied.

Asset Allocation Strategy. The company’s pension planassets are held in trust. The asset allocation was as follows:

As of February 29 or 282004 2003

Target Actual ActualAllocation Allocation Allocation

Equity securities 80% 80% 79%Fixed income securities 20 20 21

Total 100% 100% 100%

Plan fiduciaries set investment policies and strategies for thepension plan. Long-term strategic investment objectivesinclude preserving the funded status of the trust and balancingrisk and return. The plan fiduciaries oversee the investmentallocation process, which includes selecting investmentmanagers, setting long-term strategic targets, and monitoringasset allocations. Target allocation ranges are guidelines, notlimitations, and occasionally plan fiduciaries will approveallocations above or below a target range.

D E B T

Total debt is summarized as follows:


Term loan $100,000 $100,000Revolving loan 4,446 56,051

Total debt 104,446 156,051Less current installments of

long-term debt — —Less short-term debt 4,446 56,051

Total long-term debt, excluding current installments $100,000 $100,000

In May 2002, the company entered into a $200 millioncredit agreement secured by vehicle inventory. During thefourth quarter of fiscal 2003, the credit agreement wasincreased from $200 million to $300 million. The creditagreement includes a $200 million revolving loan commitment

9

and a $100 million term loan. Principal is due in full atmaturity with interest payable monthly at a LIBOR-based rate.The credit agreement is scheduled to terminate on May 17,2005. The termination date of the agreement will beautomatically extended one year each May 17 unless eitherCarMax or either lender elects, prior to the extension date, notto extend the agreement. As of February 29, 2004, the amountoutstanding under this credit agreement was $104.4 million.Under this agreement, the company must meet financialcovenants relating to minimum current ratio, maximum totalliabilities to tangible net worth ratio, and minimum fixedcharge coverage ratio. The company was in compliance with allsuch covenants at February 29, 2004.

The weighted average interest rate on the outstanding short-term debt was 3.5% during fiscal 2004, 3.2% during fiscal2003, and 4.4% during fiscal 2002.

The company capitalizes interest in connection with theconstruction of certain facilities. Capitalized interest totaled$2.5 million in fiscal 2004, $1.0 million in fiscal 2003, and$0.5 million in fiscal 2002.

C O M M O N S T O C K A N D S T O C K - B A S E DI N C E N T I V E P L A N S

(A) Shareholder Rights PlanIn conjunction with the company’s shareholder rights plan,shareholders received preferred stock purchase rights as adividend at the rate of one right for each share of CarMax, Inc.common stock owned. The rights are exercisable only upon theattainment of, or the commencement of a tender offer to attain,a 15% ownership interest in the company by a person or group.When exercisable, each right would entitle the holder to buyone one-thousandth of a share of Cumulative ParticipatingPreferred Stock, Series A, $20 par value, at an exercise price of$140 per share, subject to adjustment. A total of 120,000shares of such preferred stock, which have preferential dividendand liquidation rights, have been authorized and designated.No such shares are outstanding. In the event that an acquiringperson or group acquires the specified ownership percentage ofCarMax, Inc. common stock (except pursuant to a cash tenderoffer for all outstanding shares determined to be fair by theboard of directors) or engages in certain transactions with thecompany after the rights become exercisable, each right will beconverted into a right to purchase, for half the current marketprice at that time, shares of CarMax, Inc. common stock valuedat two times the exercise price. The company also has anadditional 19,880,000 shares of undesignated preferred stockauthorized of which no shares are outstanding.

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4 2 C A R M A X 2 0 0 4

(B) Restr icted StockThe company has issued restricted stock under the provisionsof the CarMax, Inc. 2002 Stock Incentive Plan wherebymanagement and key employees are granted restricted sharesof common stock. Shares are awarded in the name of theemployee, who has all the rights of a shareholder, subject tocertain restrictions or forfeitures. Restrictions on the awardsgenerally expire three or four years from the date of grant.Total restricted stock awards of 228 shares were granted infiscal 2004. In fiscal 2003, 25,984 restricted shares wereexchanged in connection with the separation.

At the date of grant, the market value of all shares grantedis recorded as unearned compensation and is a component ofequity. Unearned compensation is expensed over therestriction periods. The total charge to operations was$121,500 in fiscal 2004; $77,400 in fiscal 2003; and $99,700in fiscal 2002. Outstanding shares of restricted common stockat February 29, 2004, and February 28, 2003, were 25,817and 27,275, respectively.

(C) Stock Incentive PlansUnder the company’s stock incentive plans, nonqualified stockoptions may be granted to management, key employees, andoutside directors to purchase shares of common stock. Theexercise price for nonqualified options is equal to, or greaterthan, the market value at the date of grant. Options generallyare exercisable over a period from one to ten years from thedate of grant. The company has authorized 10,100,000 sharesof common stock to be issued as either options, restrictedstock grants, or stock grants. Shares of common stock availablefor issuance of options, restricted stock grants, or stock grantstotaled 3,661,200 at February 29, 2004.

The company’s stock option activity is summarized in Table 2.Table 3 summarizes information about stock options outstandingas of February 29, 2004.

(D) Employee Stock Purchase PlanThe company has an employee stock purchase plan for allemployees meeting certain eligibility criteria. Under the plan,eligible employees may, subject to certain limitations, purchaseshares of common stock. For each $1.00 contributed by employeesunder the plan, the company matches $0.15. Purchases are limitedto 10% of an employee’s eligible compensation, up to a maximumof $7,500 per year. The 2002 CarMax, Inc. Employee StockPurchase Plan allows employees to purchase up to 1,000,000shares of common stock. The source of the shares available forpurchase by employees may, at the company’s option, be openmarket purchases or newly issued shares.

At February 29, 2004, a total of 741,847 shares remainedavailable under the plan. Shares purchased on the open market onbehalf of employees were 161,662 during fiscal 2004; 213,931during fiscal 2003; and 183,902 during fiscal 2002. The averageprice per share purchased under the plan was $29.97 in fiscal2004, $19.43 in fiscal 2003, and $17.13 in fiscal 2002. Thecompany match totaled $598,600 in fiscal 2004; $520,700 infiscal 2003; and $384,800 in fiscal 2002.

(E) 401(k) PlanThe company sponsors a 401(k) plan for all employees meetingcertain eligibility criteria. Under the plan, eligible employees cancontribute up to 40% of their salaries, and the company matchesa portion of those associate contributions. The total expense forthis plan was $1.1 million in fiscal 2004, $1.0 million in fiscal2003, and $885,000 in fiscal 2002.

TABLE 2


Weighted Average Weighted Average Weighted Average(Shares in thousands) Shares Exercise Price Shares Exercise Price Shares Exercise Price

Outstanding at beginning of year 4,345 $10.25 3,631 $ 4.81 4,107 $3.16Granted 2,154 $14.59 1,134 $26.22 1,659 $4.94Exercised (693) $ 6.53 (285) $ 5.06 (1,941) $1.32Cancelled (130) $14.88 (135) $ 9.03 (194) $5.95

Outstanding at end of year 5,676 $12.24 4,345 $10.25 3,631 $4.81

Options exercisable at end of year 1,839 $ 8.02 1,440 $ 6.08 821 $6.85

TABLE 3

Options Outstanding as of February 29, 2004 Options Exercisable as of February 29, 2004Weighted Average

(Shares in thousands) Number Remaining Weighted Average Number Weighted AverageRange of Exercise Prices Outstanding Contractual Life Exercise Price Exercisable Exercise Price

$ 1.63 646 3.0 $ 1.63 414 $ 1.63$ 3.22 to $ 4.89 1,289 4.0 $ 4.82 553 $ 4.78$ 6.06 to $ 9.19 565 2.1 $ 6.56 565 $ 6.56$12.94 to $20.00 2,159 8.8 $14.33 59 $14.88$22.47 to $43.44 1,017 5.1 $27.14 248 $27.71

Total 5,676 5.7 $12.24 1,839 $ 8.02

E A R N I N G S P E R S H A R E

CarMax was a wholly owned subsidiary of Circuit City duringa portion of the periods presented. Earnings per share forfiscal 2003 and 2002 have been presented to reflect the capitalstructure effective with the separation of CarMax fromCircuit City. All earnings per share calculations have beencomputed as if the separation had occurred at the beginningof the periods presented.

Reconciliations of the numerator and denominator of basicand diluted earnings per share are presented below:

Years Ended February 29 or 28(In thousands except per share data) 2004 2003 2002

Weighted average common shares 103,503 102,983 102,039

Dilutive potential common shares:

Options 2,113 1,579 1,950Restricted stock 12 8 33

Weighted average common shares and dilutive potential common shares 105,628 104,570 104,022

Net earnings available to common shareholders $116,450 $94,802 $90,802

Basic net earnings per share $ 1.13 $ 0.92 $ 0.89Diluted net earnings

per share $ 1.10 $ 0.91 $ 0.87

Certain options were outstanding and not included in thecomputation of diluted earnings per share because theoptions’ exercise prices were greater than the average marketprice of the common shares. Options to purchase 18,364shares of CarMax, Inc. common stock with exercise pricesranging from $35.23 to $43.44 per share were outstandingand not included in the calculation at the end of fiscal 2004;1,053,610 shares with exercise prices ranging from $18.60 to$43.44 per share at the end of fiscal 2003; and 15,364 shareswith exercise prices ranging from $37.49 to $43.44 per shareat the end of fiscal 2002.

L E A S E C O M M I T M E N T S

The company conducts a substantial portion of its business inleased premises. The company’s lease obligations are basedupon contractual minimum rates. CarMax operates 23 of itssales locations pursuant to various leases under which its formerparent Circuit City was the original tenant and primary obligor.Circuit City had originally entered into these leases so thatCarMax could take advantage of the favorable economic terms

12

11 available to Circuit City as a large retailer at that time. CircuitCity has assigned each of these leases to CarMax. Despite theassignment and pursuant to the terms of the leases, Circuit Cityremains contingently liable under the leases. In recognition ofthis ongoing contingent liability, CarMax made a one-timespecial dividend payment of $28.4 million to Circuit City onthe October 1, 2002, separation date.

Rental expense for all operating leases was $54.2 million infiscal 2004, $48.1 million in fiscal 2003, and $41.4 million infiscal 2002. Most leases provide that the company pay taxes,maintenance, insurance, and operating expenses applicable tothe premises. The initial term of most real property leases willexpire within the next 20 years; however, most of the leaseshave options providing for renewal periods of 5 to 20 years atterms similar to the initial terms.

As of February 29, 2004, future minimum fixed leaseobligations, excluding taxes, insurance, and other costs payabledirectly by the company, were approximately:

Operating Lease(In thousands) Commitments

2005 $ 58,2052006 58,9402007 57,4322008 57,6412009 57,9132010 and thereafter 602,902

Total minimum lease payments $893,033

In fiscal 2004, the company entered into three sale-leaseback transactions covering nine superstore propertiesvalued at approximately $107.0 million. These transactionswere structured as operating leases with initial terms of either15 or 20 years with various renewal options. In fiscal 2003,the company entered into a sale-leaseback transactioncovering three superstore properties valued at approximately$37.6 million. This transaction was structured with initiallease terms of 15 years and two 10-year renewal options. Allsales-leaseback transactions are structured at competitiverates. Gains on sale-leaseback transactions are deferred andamortized over the term of the leases. The company does nothave continuing involvement under the sale-leasebacktransactions. In conjunction with certain sale-leasebacktransactions, the company must meet financial covenantsrelating to minimum tangible net worth and minimumcoverage of rent expense. The company was in compliancewith all such covenants at February 29, 2004.

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C O N T I N G E N T L I A B I L I T I E S

(A) Lit igat ionIn the normal course of business, the company is involved invarious legal proceedings. Based upon the company’s evaluationof the information presently available, management believesthat the ultimate resolution of any such proceedings will nothave a material adverse effect on the company’s financialposition, liquidity, or results of operations.

(B) Other MattersIn accordance with the terms of real estate lease agreements, thecompany generally agrees to indemnify the lessor from certainliabilities arising as a result of the use of the leased premises,including environmental liabilities and repairs to leasedproperty upon termination of the lease. Additionally, inaccordance with the terms of agreements entered into for thesale of our properties, the company generally agrees toindemnify the buyer from certain liabilities and costs arisingsubsequent to the date of the sale, including environmentalliabilities and liabilities resulting from the breach ofrepresentations or warranties made in accordance with theagreements. The company does not have any known materialenvironmental commitments, contingencies, or otherindemnification issues arising from these arrangements.

As part of its customer service strategy, the companyguarantees the vehicles it sells with a 30-day limited warranty. Avehicle in need of repair within 30 days of the customer’spurchase will be repaired free of charge. As a result of thisguarantee, each vehicle sold has an implied liability associatedwith it. As such, the company records a provision for repairsduring the guarantee period for each vehicle sold based onhistorical trends. The liability for this guarantee was $1.4 millionat February 29, 2004, and $1.3 million at February 28, 2003,and is included in accrued expenses and other current liabilitiesin the consolidated balance sheets.

R E C E N T A C C O U N T I N GP R O N O U N C E M E N T S

In May 2003, the FASB issued SFAS No. 150, “Accountingfor Certain Financial Instruments with Characteristics ofBoth Liabilities and Equity.” This statement establishesstandards for how an issuer classifies and measures certainfinancial instruments with characteristics of both liabilitiesand equity. SFAS No. 150 is effective for financialinstruments entered into or modified after May 31, 2003, andotherwise is effective at the beginning of the first interimperiod beginning after June 15, 2003. The application of theprovisions of SFAS No. 150 has not and is not expected tohave a material impact on the company’s financial position,results of operations, or cash flows.

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13 In December 2003, the FASB issued SFAS No. 132 (revised2003), “Employers’ Disclosures about Pensions and OtherPostretirement Benefits.” This revised statement retains thedisclosures required by the original SFAS No. 132, whichstandardized employers’ disclosures about pensions and otherpostretirement benefits, and requires additional disclosuresconcerning the economic resources and obligations related topension plans and other postretirement benefits. Theprovisions of the original SFAS No. 132 remain in effect untilthe provisions of this revised statement are adopted. Thisrevised statement is effective for fiscal years ending afterDecember 15, 2003. The company has revised its disclosuresto meet the requirements under this revised standard for thefinancial statements currently presented.

In December 2003, the FASB issued FASB Interpretation(“FIN”) No. 46 (revised December 2003), “Consolidation ofVariable Interest Entities.” This revised interpretation retainsthe original FIN No. 46 requirements for consolidatingvariable interest entities by the primary beneficiary of theentity if the equity investors in the entity do not have thecharacteristics of a controlling financial interest or do not havesufficient equity at risk for the entity to finance its activitieswithout additional subordinated financial support from otherparties. The revised interpretation adds the requirement forconsolidating an entity where the equity investors’ voting rightsare not proportionate to their economic interests and where theactivities of the entity involve or are conducted on behalf of aninvestor with a disproportionately small voting interest. Thisrevised interpretation is effective for all entities no later thanthe end of the first reporting period that ends after March 15,2004. However, for reporting periods ending after December 15,2003, a company must apply either the original or this revisedinterpretation to those entities that are considered to be special-purpose entities. A company that has already applied theoriginal FIN No. 46 to an entity may continue to do so untilthe effective date of the revised interpretation. The companyhas applied the revised FIN No. 46, which has not had amaterial impact on the company’s financial position, results ofoperations, or cash flows.

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S E L E C T E D Q U A R T E R LY F I N A N C I A L D ATA ( U N A U D I T E D )

First Quarter Second Quarter Third Quarter Fourth Quarter Fiscal Year(In thousands except per share data) 2004 2003 2004 2003 2004 2003 2004 2003 2004 2003

Net sales and operating revenues $1,172,835 $1,005,803 $1,236,457 $1,080,682 $1,071,534 $936,819 $1,116,865 $946,640 $4,597,691 $3,969,944

Gross profit $ 147,771 $ 122,142 $ 163,105 $ 128,812 $ 126,242 $106,940 $ 133,770 $110,345 $ 570,888 $ 468,239

CarMax Auto Finance income $ 25,748 $ 19,838 $ 22,677 $ 22,110 $ 17,649 $ 19,220 $ 18,889 $ 21,231 $ 84,963 $ 82,399

Selling, general, andadministrative expenses $ 115,553 $ 93,037 $ 120,714 $ 97,997 $ 114,282 $101,810 $ 117,825 $ 99,573 $ 468,374 $ 392,417

(Gain)/loss on franchise dispositions $ — $ — $ 460 $ — $ (1,207) $ — $ (1,580) $ — $ (2,327) $ —

Net earnings $ 35,260 $ 29,238 $ 39,610 $ 31,714 $ 19,053 $ 14,717 $ 22,526 $ 19,133 $ 116,450 $ 94,802

Net earnings per share:Basic $ 0.34 $ 0.28 $ 0.38 $ 0.31 $ 0.18 $ 0.14 $ 0.22 $ 0.19 $ 1.13 $ 0.92Diluted $ 0.34 $ 0.28 $ 0.37 $ 0.30 $ 0.18 $ 0.14 $ 0.21 $ 0.18 $ 1.10 $ 0.91

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To the Board of Directors and ShareholdersCarMax, Inc.:

We have audited the accompanying consolidated balance sheets of CarMax, Inc. and subsidiaries (the “Company”) as ofFebruary 29, 2004 and February 28, 2003, and the related consolidated statements of earnings, shareholders’ equity and cashflows for each of the fiscal years in the three-year period ended February 29, 2004. These financial statements are theresponsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financialstatements based on our audits.

We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Thosestandards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements arefree of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements. An audit also includes assessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonablebasis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financialposition of CarMax, Inc. and subsidiaries as of February 29, 2004 and February 28, 2003, and the results of their operationsand their cash flows for each of the fiscal years in the three-year period ended February 29, 2004, in conformity with accountingprinciples generally accepted in the United States of America.

RICHMOND,VIRGINIA MARCH 30, 2004

I N D E P E N D E N T A U D I T O R S ’ R E P O R T

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C O M P A N Y O F F I C E R S

SENIOR MANAGEMENT TEAM

AUSTIN LIGONPresidentChief Executive Officer

KEITH BROWNINGExecutive Vice PresidentChief Financial Officer

TOM FOLLIARDExecutive Vice PresidentStore Operations

MIKE DOLANSenior Vice PresidentChief Information Officer

JOE KUNKELSenior Vice PresidentMarketing and Strategy

ANGIE SCHWARZ CHATTINVice PresidentCarMax Auto Finance

STUART HEATONVice PresidentGeneral CounselCorporate Secretary

ED HILLVice PresidentService Operations

DOUGLASS MOYERSVice PresidentReal Estate

KIM D. ORCUTTVice PresidentController

TOM REEDYVice PresidentTreasurer

CORPORATE AND F IELD MANAGEMENT TEAM

ANU AGARWALAssistant Vice PresidentMerchandising

ROD BAKERRegion Vice PresidentService Development

DAVE BANKSAssistant Vice PresidentManagement Information Systems

DANDY BARRETTAssistant Vice PresidentInvestor Relations

CHRIS BARTEERegion Vice PresidentMerchandisingSouthwest Region

DAN BICKETTAssistant Vice PresidentConstruction and Facilities

JEREMY BYRNESAssistant Vice PresidentCarMax Auto Finance

MIKE CALLAHANAssistant Vice PresidentCarMax Auto Finance

TIM COOLEYRegion Vice PresidentService OperationsMid-Atlantic Region

PATTY COVINGTONAssistant Vice PresidentDeputy General Counsel

JOHN DAVISRegion Vice PresidentService OperationsFlorida Region

JASON DAYRegion Vice PresidentMerchandisingAtlanta Region

LAURA DONAHUEAssistant Vice PresidentAdvertising

EDWARD FABRITIISAssistant Vice PresidentField Human Resources

JON GESKERegion Vice PresidentService OperationsSouthwest Region

TODD GIBBONSRegion Vice PresidentService OperationsCentral Region

MICHELLE HALASZAssistant Vice PresidentDeputy General Counsel

RANDY HARDENAssistant Vice PresidentMarketing

BARBARA HARVILLAssistant Vice PresidentManagement Information Systems

JACK HIGHTOWERRegion Vice PresidentSales Operations

DAN JOHNSTONRegion Vice PresidentGeneral ManagerMid-Atlantic Region

TOM MARCEYRegion Vice PresidentMerchandisingMid-Atlantic Region

BILL MCCHRYSTALRegion Vice PresidentMerchandisingFlorida Region

ROB MITCHELLAssistant Vice PresidentConsumer Finance

JOHN MONTEGARIAssistant Vice PresidentMedia

BILL NASHAssistant Vice PresidentAuction Services

JEFF RUTTENRegion Vice PresidentGeneral ManagerSouthwest Region

SCOTT RIVASVice PresidentHuman Resources

FRED WILSONVice PresidentStore Administration

CLIFF WOODVice PresidentMerchandising

MARTY SBERNARegion Vice PresidentService OperationsAtlanta Region

RICHARD SMITHAssistant Vice PresidentManagement Information Systems

WILLIAM STONEAssistant Vice PresidentStrategy

LISA VAN RIPERAssistant Vice PresidentPublic Affairs

TOM VICINIRegion Vice PresidentGeneral ManagerCentral Region

DONNA WASSELRegion Vice PresidentGeneral ManagerAtlanta Region

JOE WILSONRegion Vice PresidentMerchandisingCentral Region

TOM WULFAssistant Vice PresidentStore Operations

DUGALD YSKARegion Vice PresidentGeneral ManagerFlorida Region

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B O A R D O F D I R E C T O R S

BOARD COMMITTEES

RICHARD L. SHARPChairman of the BoardCarMax, Inc.Private InvestorRetired Chairman and Chief Executive OfficerCircuit City Stores, Inc.(a consumer electronics specialty retailer)Richmond,Virginia

KEITH BROWNINGExecutive Vice PresidentChief Financial OfficerCarMax, Inc.

JAMES F. CLINGMAN, JR.Retired President and Chief Operating OfficerH.E. Butt Grocery Company(a food retailer)San Antonio, Texas

JEFFREY E. GARTENDean,Yale School of ManagementYale UniversityNew Haven, Connecticut

W. ROBERT GRAFTONRetired Managing Partner – Chief ExecutiveAndersen Worldwide, S.C.(an accounting and professional services firm)Potomac, Maryland

WILLIAM S. KELLOGGRetired Chairman and Chief Executive OfficerKohl’s Corporation(an apparel and home products retailer)Oconomowoc, Wisconsin

AUSTIN LIGONPresidentChief Executive OfficerCarMax, Inc.

MAJOR GENERAL HUGH G. ROBINSON (RET.), P.E.Chairman and Chief Executive OfficerGranville Construction & Development Co., Inc.(a low- and moderate-income housing construction firm)Dallas, Texas

THOMAS G. STEMBERGChairman of the BoardStaples, Inc.(an office supply superstore retailer)Framingham, Massachusetts

BETH A. STEWARTChairman and Chief Executive OfficerStoretrax.com(an Internet real estate listing service)PresidentStewart Real Estate Capital, L.L.C.(a real estate investment company)Bernardsville, New Jersey

WILLIAM R. TIEFELChairman EmeritusThe Ritz-Carlton Hotel Company, L.L.C.Retired Vice ChairmanMarriott International, Inc.Palm Beach, Florida

EXECUTIVE

Austin Ligon

Keith Browning

AUDIT

W. Robert Grafton,Chairman

James F. Clingman, Jr.

Hugh G. Robinson

Beth A. Stewart

COMPENSATION ANDPERSONNEL

Hugh G. Robinson,Chairman

James F. Clingman, Jr.

W. Robert Grafton

William S. Kellogg

Beth A. Stewart

William R.Tiefel

NOMINATING ANDGOVERNANCE

William R.Tiefel,

Chairman

Jeffrey E. Garten

William S. Kellogg

Thomas G. Stemberg

CORPORATE OFFICE

CarMax, Inc.4900 Cox RoadGlen Allen, Virginia 23060-6295Telephone: (804) 747-0422

WEB S ITE

www.carmax.com

ANNUAL SHAREHOLDERS ’ MEETING

Tuesday, June 29, 2004, at 10:00 a.m.The Richmond Marriott West Hotel4240 Dominion BoulevardGlen Allen, Virginia 23060

STOCK INFORMATION

CarMax, Inc. common stock is traded on the New York StockExchange under the symbol “KMX.” Prior to the separationfrom Circuit City Stores, Inc. on October 1, 2002, the CircuitCity Stores–CarMax Group common stock was traded on theNYSE under the same symbol.

At February 29, 2004, there were approximately 7,100 CarMaxshareholders of record.

QUARTERLY STOCK PRICE RANGE

The following table sets for th by fiscal quar ter the high andlow reported prices of the company’s common stock for thelast two fiscal years:

First Second Third FourthQuarter Quarter Quarter Quarter

Fiscal 2004

High $24.10 $38.72 $39.30 $37.10

Low $12.45 $23.08 $30.08 $28.71

Fiscal 2003

High $34.00 $26.75 $21.45 $20.47

Low $24.75 $13.00 $12.90 $12.94

DIVIDEND POLICY

To date, CarMax has not paid a cash dividend on its commonstock. The company presently intends to retain its earnings foruse in its operations and for geographic expansion and, there-fore, does not anticipate paying any cash dividends in the fore-seeable future.

INDEPENDENT AUDITORS

KPMG LLP1021 East Cary Street, Suite 2000Richmond,Virginia 23219-4023

TRANSFER AGENT AND REGISTRAR

Contact our transfer agent for questions regarding your stockcer tificates, including changes of address, name, or ownership;lost cer tificates; or to consolidate multiple accounts.

Wells Fargo Shareowner ServicesP.O. Box 64854South St. Paul, Minnesota 55164-0854Toll free: (800) 468-9716Hearing impaired: (651) 450-4144www.wellsfargo.com/shareownerservices

FINANCIAL INFORMATION

For quar terly sales and earnings information, financial reports, filings with the Securities and Exchange Commission(including Form 10-K), news releases, and other investor information, please visit our investor Web site athttp://investor.carmax.com. Information may also be obtained from the Investor Relations Department at:E-mail: [email protected] Telephone: (804) 747-0422, ext. 4489

Our chief executive officer and chief financial officer have filed the cer tifications required by Section 302 of the Sarbanes-Oxley Act of 2002 with the Securities and ExchangeCommission as exhibits to our Form 10-K for the fiscal yearended February 29, 2004. In addition, our chief executive officer is required to file a separate annual cer tification withthe New York Stock Exchange following our annual share-holders’ meeting.

CORPORATE GOVERNANCE INFORMATION

Copies of the CarMax Corporate Governance Guidelines, theCode of Conduct, and the char ters for each of the AuditCommittee, Compensation and Personnel Committee, andNominating and Governance Committee are available from ourinvestor Web site, at http://investor.carmax.com, under the cor-porate governance tab. Alternatively, shareholders may obtain,without charge, copies of these documents by writing toInvestor Relations at the CarMax corporate office.

INVESTOR RELATIONS

Security analysts are invited to contact:Dandy Barrett, Assistant Vice President, Investor Relations Telephone: (804) 935-4591

GENERAL INFORMATION

Members of the media and others seeking general information about CarMax should contact:Lisa Van Riper, Assistant Vice President, Public Affairs Telephone: (804) 935-4594

C O R P O R A T E A N D S H A R E H O L D E R I N F O R M A T I O N

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carmax, inc. annual report

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